Dr Jacques Bughin, UN consultant, Solvay Business School ULB, Portulans Institute and G20Y, former Director McKinsey Global Institute, and senior partner McKinsey & Company.
No doubt that the socio-economic effect of the COVID-19 pandemic might have a significant effect on our economies, and more broadly on our life. The question raised by many is how big the effect might be, and how quickly one can one recover.
After each pandemic, a literature has emerged on the topic, trying to estimate the negative effect of a pandemic, on one side, and attempting on the other side to see how the shocks may be absorbed to return to a new normal, if anything.
The tagline for the optimist has been that a pandemic may be costly, but often recovers very quickly, exhibiting a classical «V» type situation. Others would argue that excess-mortality pandemics are different, and may build significant and lasting damages, requiring significant support plans in order to get fast out of a dragging crisis.
In general, the consensus has been that the costs of pandemics are not small. In effect, pandemic outbreaks may exert a significant pressure of economic activity in the short and long term, but the effect is closely related to how global and lethal the outbreak crisis will be. This ranges from a low 1-2% decline in GDP worldwide, (as well as a quick recovery limiting effect to nil in long term), to as much as 5 to 10% for significant pandemics taking over millions of lives and spreading across the full globe (e.g. World Bank, 2020; McKibbin and Fernando, 2020; Baker et al., 2020). Such archetype of pandemics can have a structural effect in long term of declining real interest rates, as result of lower trend in investments and higher precautionary savings, as argued by Jorda et al. (2020).
The long-term impact is important indeed, but the evidence suggests that on average, it only kicks in after 5 to 10 years, at the exception of some countries in the past, especially Spain or Italy (Jorda et al., 2020). We rather should also be concerned on the short to medium term impact, as this is where the largest discounted value impact will be perceived, and the effects of a global pandemic like the COVID-19 outbreak may suggest a negative impact of the order of magnitude larger than the Great Depression in the US (Figure 1).
Figure 1: Estimates of pandemic costs worldwide
While using GDP as a yardstick of the pandemic effect, we prefer to look at a more global indicator, welfare loss. In particular, the effects of illness and mortality directly affects the ability of a healthy life from a pandemic and should be included in costs beyond GDP. Likewise, major uncertainty builds up as a result of the disruptions induced by, or in reaction to, the outbreak.
Hence, in a recent post,1 we calibrated a model of COVID infections, taking into account the emerging consensus about epidemiologic data linked to COVID-19 on welfare. The estimates related to two experiments, one with no containment, whereby one is aiming for herd immunity (a strategy followed by some countries such as Sweden and the Netherlands), and the other where countries are taking major containment measures to be able to flatten the curve of the epidemic, and get health system to support the sick (happening in close to half of countries to date).
Five messages are emerging from this work, when toying again with the data.
- The importance of going beyond GDP. We find that welfare losses are two times larger than GDP costs alone, as a result of counting healthy days of life lost, and major uncertainty reducing citizens income as a result of risk aversion, and more needs for precaution (Figure 2).
Figure 2: Welfare versus GDP impact due to the COVID-19
- Containment or not does not change much of the total costs of pandemic (roughly, 11.5% decrease cumulated after one year), but changes the timing and nature of those costs. Among others, containment allows to limit the risk of contagion, protecting health, but meanwhile, it creates major disruptions to the economy, by closing down many activities, and limiting the interactions to a much larger population than the actually infected in the early days of the pandemic (Figure 3).
Figure 3: How welfare loss builds up due to the COVID-19
- The shape of the recovery does not look like a quick «V», except if everything reverses quickly (one quarter lag) at a rate above 50%, and only for the case of containment, because containment has limited the sunk cost aspect of health impact, versus no containment (Figures 4 and 5).
Figures 4 and 5: Size of recovery and evolution of welfare due to the COVID-19
- In general, at just 50% recovery, there is a lasting welfare gap, at 4%, versus base case, whatever the action strategy used. This thus requires to have policies that remove any barrier to slow recovery (Figure 6).
Figure 6: The lasting welfare gap due to the COVID-19
- Last but not least, the shock is not distributed equally in the population. Under no containment, deaths are disproportionately affecting the old population; under containment, the economic effect is mostly affecting the working age population.
In conclusion, our back of the envelope analysis make clear that, under a welfare lens perspective, the welfare shock linked to COVID-19 may be twice as large as what is often heard from a lens of GDP alone. This welfare lens also tells us more on the importance of policies to adopt. First, prevention policies are key to implement as quickly as possible, targeting the contaminated to limit the risk of full shut down. Second, containment not only flattens the curve, but is a better policy bet during recovery.
Third, recovery must be such that there is an as large as possible boost. A 50% recovery may make the crisis last long; everything we might do to increase the odds and speed of recovery will be crucially important, including the control of extra likely inevitable new waves to come of outbreak in the months to come, regarding COVID-19.
Baker, S. R., Bloom, N., Davis, S. J., & Terry, S. J. (2020), “Covid-induced economic uncertainty,” (No. w26983). National Bureau of Economic Research.
Lee and McKibbin, (2003), “Globalisation and disease: the case of SARS,” Asian economic papers.
McKibbin, Warwick J., and Roshen Fernando. “The global macroeconomic impacts of COVID-19: Seven scenarios,” (2020), National Bureau of Economic Research.
Jonas, (2013), “Pandemic risk,” World Bank.
Jorda, O., Singh, S. R., & Taylor, A. M. (2020), “Longer-run economic consequences of pandemics,” (No. w26934). National Bureau of Economic Research.
Avalos and Zakrajsek, (2020), “Covid 19 and SARS: what do the stock markets tell us,” BIS Quarterly Review, March.
Keogh-Brown, M.R., Smith, R.D., Edmunds, J.W. et al., “The macroeconomic impact of pandemic influenza: estimates from models of the United Kingdom, France, Belgium and The Netherlands,” European Journal of Health Economics 11, 543–554 (2010).
Orlik, Tom, Jamie Rush, Maeva Cousin, and Jinshan Hong, (2020). “Coronavirus Could Cost the Global Economy $2.7 Trillion. Here’s How,” Bloomberg.
Maliszewska, M., Mattoo, A., & Van Der Mensbrugghe, D. (2020), “The Potential Impact of COVID-19 on GDP and Trade: A Preliminary Assessment.” World Bank Policy Research Working Paper, (9211).
© Jacques Bughin. Comments more than welcome. All errors are mine. References listed as they are found in the text.