The costs of Europe’s economic hibernation
Economists begin to put numbers on the impact of unprecedented global containment policies
A pernicious element of the Covid-19 crisis is that measures needed to save lives (strict societal confinement) cause maximum short-run economic damage.
This trade-off — between drastic containment and the continuation of normal economic activity — is confronting governments across the world and provoking a wide range of answers.
Forecasters are also beginning to flesh out what unparalleled social restrictions will mean for our economies. The hope underpinning the strategy is to “press pause on the economy, save lives, and then press play again”, writes Marcus Walker at the Wall Street Journal. In Spain, which has imposed a two-week suspension on all “non-essential work”, the government has taken to calling it a period of enforced economic “hibernation”.
But can our economies simply jump-start after a period of coronavirus-enforced slumber? One of the main variables is the length and severity of the measures placed on households and businesses.
The Netherlands’ central planning bureau (CPB), which analyses government policy, is one of the first forecasters to attempt to model the impact. The CPB found that the relationship between the duration of restrictive measures and the corresponding impact on gross domestic product, the labour force and public finances is not directly linear (see table below). That is to say that every additional month of containment does not result in the same deterioration in economic activity.
For example, a restriction period of a month in the Netherlands will result in a loss of 1.2 per cent in growth in 2021; three months will result in 5 per cent shrinkage. A still more dramatic prolongation of confinement from six months to 12 months results in a marginally less severe contraction this year (-7.3 per cent instead of -7.7 per cent) but causes a protracted recession in 2021.
The modelling can help inform policymakers on the novel challenges posed by a pandemic compared with a financial or sovereign debt crisis. Simon Wren-Lewis, an economist at Oxford university, has some very useful pointers on the dynamics involved in a health crisis from his work on the economic impact of influenza in the 1990s. He says an important factor to consider is the possibility of permanent changes to people’s consumption habits (or “demand shocks” in the jargon) long after containment phase is over:
“A lot of our consumption nowadays can be called social, by which I mean doing things that bring you into contact with other people. Things like going to the pub, to restaurants, to football matches or travel.
One reason it is severe is that it is partly a permanent loss. Maybe you will have a few more meals out once the pandemic is over to make up for what you missed when you stayed home, but there is likely to be a net fall in your consumption of meals out over the year. What I realised when I did the analysis was just how much of our consumption was social.”
The probability of “V-shaped”, “U-shaped” or “L-shaped” recoveries will be heavily dependent on the magnitude of the policy response but also on the possible lasting impact that the containment measures have on human behaviour.
Economists at Deutsche Bank estimate that the eurozone is in line to suffer an 11.4 per cent GDP contraction in the second quarter of 2020. They think that the recovery — should restrictions begin to fall away in the second half of the year — will be a “gradual” return to pre-crisis times. The pace will be dependent on the degree of “scarring” present in the economy:
“We judge this on the basis of the rise in unemployment, which differs country by country depending on structural factors and the success of the policy response to keep businesses afloat and workers in jobs. Even by mid-2021, GDP is still expected to be running 3-4% below pre-virus levels in Italy and Spain.”
History can also offer some pointers — but not always ones that provide comfort. This fascinating study from the Federal Reserve of San Francisco examines the long-run economic impact of 12 global pandemics stretching back to the 14th century. They find that destruction caused to capital and labour suggest that “significant macroeconomic after-effects of the pandemics persist for about 40 years”.