How large a GDP loss under “Level 4”?

I’ve mentioned in posts over the last few days The Treasury’s estimate that the current “Level 4” restrictions will have reduced GDP by about 40 per cent relative to normal levels and the Reserve Bank’s estimate of a 35 per cent reduction.    Both estimates seem a lot more realistic than some of the private sector estimates that were still doing the rounds early in the week.  But I still reckon the Reserve Bank estimate, in particular, is almost certainly too low –  especially if we are concerned, as we should be, with the “true” reduction in the volume of economic activity, not with what SNZ may initially report (accurate measurement is going to be a challenge).

What makes me sceptical?  Well, there is the fact that our partial lockdown seems to be more restrictive, particularly (but not exclusively) on economic dimensions, than those in many other countries.  Thus ANZ yesterday ran this chart of some Oxford index of restrictiveness.

oxford response

Some weeks ago, the French national statistical agency published its estimate that the French economy was then running 35 per cent below normal levels.   Overnight, I noticed the Governor of the Bank of England endorsing the UK Office of Budget Responsibility’s view that UK output had fallen 35 per cent since their lockdown began – and not only will activity levels already have been weakening prior to that but, as the chart illustrates, the UK lockdown is less severe than New Zealand’s.

I also listened again to the Reserve Bank testimony to the select committee on Thursday and noticed that Assistant Governor refer to OECD estimates of a 30 per cent reduction as some sort of baseline estimate for New Zealand, but as I noted in a post here on those estimates they were done (a) for direct effects only, and (b) for a constant (across countries) set of assumptions about lockdowns, just distinguishing between countries by their initial economic structures.  In an initial lockdown period, indirect effects may not matter much, but different degrees of lockdown intensity certainly do.  As just one example, many countries have not prohibited construction work, but New Zealand (mostly) did, and construction alone is perhaps 8 per cent of New Zealand’s GDP.

I was also interested to see this footnote in the Treasury scenarios paper the other day

“MBIE estimates that the essential workforce numbers around 640000, with 510000 of those not able to work from home, while the number of non-essential workers that are unable to work from home is around 1.1 million people, or 49% of the workforce”

I’m not quite sure where they get those numbers from – according to the HLFS, for example, there were 2.648 million people “employed in the labour force” (which includes employers and the self-employed in December) –  but presumably there is some good basis for their estimates.  If they happen to be right that 49 per cent of the workforce is both non-essential and can’t work from home, that alone should produce a very substantial reduction in GDP –  even if less than half if we assume (as I do) that the people unable to work from home are in jobs that are, on average, lower productivity.  Even if the 1.1 million people unable to work from home is really over a denominator of 2.648 million, that is still 42 per cent of the workforce.

But even of those who are left –  able to work from home, or working on site as “essential” –   what do we suppose the average productivity level is like?  It is most unlikely to be normal levels.  And some of those essential services are being very lightly utilised at present –  think of hospitals.  I don’t suppose, for example, that immigration call centres are very busy.

In his presentation to the select committee, the Reserve Bank’s Assistant Governor ran through some sector-by-sector numbers to support his 35 per cent estimates.    The numbers he cited (no sources provided, but perhaps MBIE as well?) were:

Food and accommodation:  16 per cent of normal

Construction:                          25 per cent of normal

Manufacturing:                      60 per cent of normal

Primary:                                   76 per cent of normal

Government:                            80 per cent of normal

That seemed to satisfy Simon Bridges, chair of the committee, who responded “oh, so 30 per cent of the economy at 80 per cent?” and Hawkesby offered no dissent.

However, even though in normal times government revenue and expenditure are equal to about 30 per cent of GDP, the share of government activity (employment, production, purchases etc) is much smaller than that (lots of the rests is just transfers: welfare benefits etc).   The last detailed national accounts I could see on the SNZ website were for the year to March 2018 and in that year government as a whole accounted for only 16.8 per cent of GDP –  3.2 percentage points of that local government.

And even if there are significant chunks of government that are at least as busy as ever (Police, Ministry of Health, Treasury) there will be lots that just aren’t working at all (no work to do, no working from home capability, Level 4 prohibitions or whatever).  Just at a local government level, are libraries open, streets being swept, public gardens maintained, pools open? No, of course not.  Of those who are working, most will be working at less than normal productivity/levels of output (whether because working from home generally isn’t as suitable, distractions of children at home, or whatever).

I was also a bit surprised by the Bank’s assumptions around construction –  sure urgent repairs etc can be done, but at the peak of a building boom, can that have been anything like 25 per cent of the sector? –  and manufacturing, even allowing for the importance primary food processing plays in New Zealand manufacturing (building supplies, including cement, is also a large chunk of New Zealand manufacturing).

I went through the detailed (50+ sub-sectors) national accounts data and did some rough estimates myself.   There are clearly some sectors where there is no reduction in output at all (eg the imputed rent on owner-occupied housing, and actual volumes for public and private rents, and –  most probably –  agricultural production).  There are others where activity will have dried up almost entirely.  There is also quite a bit of uncertainty over all the numbers, but my bottom line was something between 40 and 45 per cent less GDP than normal under “Level 4” conditions.  That is a bit less than I had previously thought, and not that out of line Treasury’s estimates, but still rather higher than the Reserve Bank’s numbers.

There is no real certainty about any of it, but these numbers aren’t just of some obscure academic or historical interest.   Recall that a month’s GDP is roughly equal to $26 billion.   If we allow –  as Treasury does –  that even under “Level 1” there is a 7.5 per cent output loss, and that under Level 4 a 42.5 per cent output loss, that is a $9 billion loss (very little of which will ever be made back) for each month.     That overstates a bit, since the realistic choice at present seems to be between something very restrictive indeed, and some like “Level 2”, which will still have –  on both Treasury and Bank estimates –  incremental output losses.   And whatever governments mandate, there would still be activities citizens simply choose not to do.   But whichever way you cut it, these are still very big numbers that need to be factored in when the Cabinet makes decisions.

One day, when the Official Information Act finally forces the papers out of “the most open and transparent government ever”, we may finally see how their official advisers have attempted to do the sort of cost-benefit analysis that should have been being done at each stage of the process.



28 thoughts on “How large a GDP loss under “Level 4”?

  1. Michael,

    I do not know what methodology is used, but a simple one is to look at D(Y) / D(L) = a * (Y/L), where D(Y) is the change in real GDP and D(L) is the change in labor, thus the ratio is the marginal product of labor. The parameter (a) is the share of labor, which is equal to the total compensations to employee / nominal GDP ratio and is available on the National Income Stats. It is approximately 0.40. Compute D(Y) = a*(Y/L)*D(L). If real GDP is 250 billion, L is 2,650,000, and a is 0.40 you can plus whatever estimates of the change in labor on the RHS and find out the fall in real GDP. If labor goes down by 1,000,000 people then real GDP falls 15 percent. If labor falls by 1.5 million workers, GDP falls by 22 percent. If labor falls by the whole 2,650,000 people then obviously GDP falls by 40 percent. That is the max it could fall because of a decline in labor.


      • Sure I thought you were talking about labor in your blog.

        To deal with unused K, add the term b*(Y/K)*D(K) to the term we had. You would get higher number. Also, if you carry on with this exercise someone will say oh but some human capital is unused too. Technical progress stopped.

        Others might look at it from the expenditures side as consumption fell, investment, and trade (G increased) and find out what happens to GDP.

        What I find more worrying is whether the recession is going to be 2 quarters or a year or longer!

        More important is what do. Government should have scenarios (35% decline, 45% etc) and policy recommendations for each scenario.


      • Thanks Weshah. I simply took for granted that at any point in time existing labour and existing capital are complements.

        Agree with your later comments. There should be such analysis and advice and it shld be published without undue delay.


      • Sorry everyone, I did not hit the reply button, I should have.


        I was assuming capital is fixed in the short run, no change. If you assume that output can fall by no more than the share of labor.


  2. Michael – There was much talk about supply line disruption during February as China shuttered (Think Hyundai, KIA ETC, etc etc), now there i stalk of some smaller part suppliers in these chains who may fail completely.

    Now China is reopening, they are finding a stack of cancelled orders from India , Vietnam, Italy , USA etc).

    While NZ primary agriculture is somewhat isolated from many of these issues , how much effect will this disappearing Global GDP have on the price we can achieve for our agricultural produce? Everyone one needs food, few can afford a lamb roast.


    • Yes, I expect our commodity prices to do rather poorly before long. Dairy has probably been held up a bit by the NZ drought, but even beyond a weakening demand story don’t forget the oil/dairy nexus: not only do lower oil prices reduce demand from oil exporters, but they also worsen economics of biofuels etc, tending to make grain cheaper, in turn an input to US grain-fed cattle. Not sure how strong that sort of effect still is, but it isn’t positive for global dairy prices.


  3. I compute a live New Zealand commodity price index.

    It’s a little tricky given that many of our commodities aren’t traded on transparent markets. So I capture some data from spot markets (e.g. gold, crude oil, iron ore), some from auction markets (dairy) and some from the OTI’s. But the index is down 14% year-to-date. In terms of percentage declines, the largest, unsurprisingly is crude petroleum (-62.9%) followed by crustaceans (-41.9%), wool (-28.5%), forest products (-24.3%). The overall impact on the ToT has been cushioned by the fall in oil prices.

    You are right that a fall in petroleum prices will impact the feed-to-price ratio in the US and this impacts US production (I have a chart of that in my latest OMF Dairy Monthly out this coming week) but I don’t think that’s really going to have a big effect.

    The big story in dairy is the collapse in the food service industry. Many US and EU dairy companies supply milk and cream directly into the major city consumers (e.g. McDonalds, Pret, Costa) and can’t simply shift their production. Or the provide boutique packaged products such as school milk (US) or UHT, butter and cheese (for airlines). They can’t simply shift production away from these items. It’s a major capital investment and also requires significant shifts in logistics, sales and marketing. All of which takes time, money and a lot of legal issues, which can’t be sorted out right now. So farmers in the UK/US are dumping milk… meanwhile, there’s a shortage at the supermarket end. The dairy story is pretty complex…

    Liked by 1 person

    • Thanks Peter for the complete layman yours is a comment I can understand.
      Whether the national GDP is down 25% or 75% for one month means little to me since the concept of measured productivity just seems weird. The last time I made that comment Mr Reddell replied that the quirks didn’t matter because statisticians use the same methods so it permitted comparision from one period to another and changes in GDP allowed comparison between countries. This epidemic is changing too many variables all at once so I’m not sure we can compare our GDP successes and failures except over long periods – maybe the next five years will reveal useful comparisons of NZ, Australia, China, the EU and the USA.
      I can see the workers in my home bubble; on one hand they are finding things much harder to do but on the other taking advantage of flexible working. The social worker in my bubble is doing essential work but with a workload that is most likely changing. Maybe during the lockdown the young and troubled are getting into less trouble or maybe they are just building up steam – whichever it is measuring the productivity of a social worker is hard to comprehend.
      I remember reading a few years ago that when the communist central planning collapsed in the USSR Moscovites had the advantage of a minimal supply chain. The efficient supply of fresh food to a city being beyond the capacity of their central planners (they could put the first man in space so it wasn’t lack of education). Most Russian produce was local and either farmers drove it to the city or city dwellers drove out to the nearest farms. World trade depends on many links in a long supply chain and whether some eat or goes hungry will depend on every link working. I’m happy to be in New Zealand.


  4. Most Russian produce was local and either farmers drove it to the city or city dwellers drove out to the nearest farms

    And sold it at the cost that many potential buyers could not afford. The poverty was indescribable…


    • I remember reading an equivalent political / economic upheaval would have caused starvation in a western country. Your point about economic catastrophes presenting opportunities should be noted by our exporters. This world wide disruption will lead to poverty that will be difficult to describe. Maybe NZ govt should be thinking about international food aid.


      • Imagine a grocery shop where the only items on the shelves are vinegar and mineral water. I lived in such a country for 18 very long months. This “great availability” of groceries was due to a version of misguided and poorly executed “quantitative easing” together with significant collapse in production induced by an industrial unrest.

        Liked by 2 people

  5. Here is a back of the envelope calculation I did after a few wines late at night and posted on No Minister a few weeks back. Just pasting here for the record. Probably a bit on the tough side and should have given a range.

    GDP to December 31 2019, $310 Billion less 4 weeks enforced holiday $25.9b, less half that again for a slow recovery back to normal trading, say another $12b, less the part of the economy not coming back for at least a year (tourism, Air NZ etc) lets call that 10% of the economy, plus another 5% just to be conservative (unforeseen s..t) equals:

    $310-25.9-12-31-15.5 = GDP of $225 billion.

    Not quite 1/3 of the economy down the toilet. Hopefully somebody here can prove my maths wrong.



  6. That chart – “Oxford index of restrictiveness” – is interesting.

    There seems to be an intense patriotic pride felt by many for living in a country that has gone to the extreme. Even if it’s the right thing to do it seems an odd thing to feel pride in…..even more so given we can’t even be sure of the results of these measures.


    • Intense patriotic pride? Or an undercurrent of masochism? 😉 I do think we kiwis have a perverse relationship to “no pain, no gain” ie the worse we feel, the harder we’re trying..

      I can’t help think that this dynamic (along with a poor sense of self-esteem + a naive faith in the external expertise of the IMF) was responsible for the unnecessary destruct of industry in the 80s (with Australia as the comparator).

      I’m extremely concerned we’re in a similar position now with Covid and that we don’t seemed to have internalised that lesson. Still the deference to the (medical) “experts” despite strong critiques of their reasoning, and the poor demonstrated track record of their models.

      We’re at extreme risk of flagellating the economy and ourselves driven by an essentially emotional prostration before a non-existent G_d.


      • As you noted, the reliability of experts’ predictions in recent years has not exactly been outstanding in the recent years. Suffice to recall the Y2K bug, WMD allegations preceding the invasion of Iraq or various health scares of the last two decades. The present crisis is not exceptional in this regard. It is difficult to comment on what appears to be quite opaque decision making process but one particular aspect is rather striking – the decision makers have been treating the model outputs as facts while in reality they are merely results of more or less complex calculations based on often, quite dubious inputs. It is very risky then to base the decisions with such far reaching consequences on the advice of the present quality. Not so much from the point of view of eventual political damage, which can be easily managed but considering the economic consequences that are already obvious even for non-economists.

        Liked by 1 person

      • Actually I’ll retract my G_d comment – we’re an irreligious lot, so that’s not it.

        Perhaps the very recent collective memory of deferring gratification whilst breaking in a new land from scratch, which conveys the visceral experience of ignoring the hard days, sticking with the plan, and grinding it out until the rewards are realised gives us a natural propensity for favouring raw endurance over stopping long enough to think through whether the current approach is still sensible is closer to the reality. the outcome is the same regardless..


      • “collective memory of deferring gratification”

        And why would you do that if you had no belief in God, or, to put it another way, no fundamental trust that the value of your sacrifice will be honoured by reality. By God.


  7. The biggest thing the pandemic is teaching us is just how leveraged the whole world is, how dependent it is on the velocity of money, and how much inequality exists.
    Effectively everyone has gone on holiday for 4 weeks and its already enough to start collapsing economies towards depression.

    Liked by 2 people

  8. New Zealand had 2 virus response choices. Containment or elimination. There is a small but growing sense that NZ has the potential eliminate the virus. If it did it would be the first nation to do so. With so few deaths and remaining registered open cases, not to try, would be irredeemably irresponsible. It has to try. If it can achieve that, the value of NZ’s food and tourism and sport and other industries would escalate. Currency, export, GDP and financial woes would evaporate.

    See todays NZ Herald. American millionaires bolt-holing to NZ. NZ would become the premier destination of choice


    • That is the sort of idealistic nonsense that has already cost the economy $35 billion over the next 12 months in business revenue GDP losses, The government has already burned through $9 billion in 3 weeks to support workers to stay in work. This is our childrens future in poverty to pay off this mounting debt.

      Start counting the suicide deaths from failed businesses and domestic violence. Start counting the cancer and other illnesses deaths from half empty hospitals.


      • Ah, but you’re forgetting the politicians best friend – linguistics.

        Jacinda just redefines “eliminate” to achieve “elimination” without, er actually eliminating anything.

        Along with the uttering the phrase “NZ determines how long we stay in lock-down” when in fact she determines it unilaterally.

        Things are getting increasingly surreal when the meaning of language can simply be redefined at will!


    • I think you are optimistic about what elimination would actually offer in economic terms. But there are huge uncertainties – that really should be captured in official advice – including around whether there will be a vaccine. If not, are we stuck behind our borders indefinitely?


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