COVID-19 is a turning point for government involvement in the economy

How can we think about government lockdowns in light of COVID-19?

The RBNZ released a report estimating the economic impact of COVID-19 containment measures back in May. They estimate that one week of alert level four (L4) costs the economy about $2.2 billion in GDP. Stats NZ recently registered a 12.2% fall in GDP for the June quarter. Sobering stuff. These are big, scary numbers. Scarier still for those in tourism or hospitality who are wearing a disproportionate amount of that cost. Clearly, there is substantial economic suffering, but how can we think about government responses?

One of the great debates of COVID-19 is whether governments should implement strict containment measures. Does the health benefit of containment outweigh the economic cost? What ‘type’ of containment is best? Globally there has been a broad spectrum of responses varying in length and strictness.

But there is more at play here than government policy. This post will explore the different responses to COVID-19 - government, population and global, and consider the extent to which the economic crash is driven by domestic containment measures. Remember the alternative is not ‘no containment measures and business as usual’ - it's living with COVID-19.

Yes, the Government shut down the economy…

In late March 2020, NZ went into L4. Containment trades population health for the economy. They reduce the length and severity of transmission, but introduce highly concentrated economic suffering. Government stimulus, such as the wage subsidy, attempts to address this suffering. As the RBNZ measures it L4 shutdown 37% of the economy. More limited containment would have cost less, but with higher rates of transmission. It's a trade-off.

OECD estimates of lockdowns globally tell a similar tale with countries like Japan and Germany shutting down about 30% of their economy. NZ’s lockdown was on the stricter end of the spectrum of containment measures.

Introducing containment measures means in theory that we can return to semi-normal life faster while avoiding high rates of COVID-19 transmission. That has happened to an extent. The return of community transmission on 11 August is obviously a hiccup. L2 costs the economy 8.8% in GDP while in place.

Stimulus packages have been key to cushioning the blow. COVID-19 stimulus dwarfed anything we saw during the Great Recession. Initiatives like helicopter payments, travel vouchers, wage subsidies and large spending programmes have been explored globally. Countries with large stimulus packages relative to the size of the economy tend to fare better. Stimulus comes at a cost to future generations, but with record low interest rates that cost is softened somewhat.

If there were no containment measures the COVID-19 the economic crash would play out very differently. While the direct hit to the economy could be softened, the crisis would evolve over a longer period with higher rates of transmission meaning we can’t go back to ‘normal’. People would determine their own precautions to stay safe - which brings us to a key point.

How society responds to COVID-19 independent of government plays a key role in the COVID-19 crash.

People aren’t behaving the same way because of COVID-19 anyway

Consumers aren’t spending and businesses aren’t producing as usual anyway. Let's call this the population response.

With no randomised trial of lockdown vs no lockdown forthcoming, we aren’t going to know exactly how large the reduction in activity is because of the population response to COVID-19. What we do understand is that people make adjustments to avoid getting sick, or making others sick. That could look like avoiding restaurants or retirement homes. It could even look like banning people from a shop for not wearing masks. The population response leads to a fall in economic activity.

Cherry-picking Sweden, a well-known example of where containment measures are relatively light, citizens have been guided to behave responsibly with more focused health information for at-risk groups (e.g. elderly, pregnant women) and hospitality. Sweden has paid the price for this with high case numbers, but with reasonably light containment measures we have the opportunity to observe the population response in action. Sweden’s economy contracted 8.6% in the second quarter. That’s still a big drop.

South Korea, which also avoided lockdown, has ‘only’ seen a decline of 3.3% for the quarter. So perhaps cherry-picking isn’t going to get us very far, there are clearly more country-specific effects (e.g. stimulus). It seems the key is both in flattening the curve and how we flattened the curve. South Korea relied on a mix of vigorous testing, targeted isolation and tracing - rather than population-wide lockdown. Case numbers fell sharply in March with a bit of a resurgence in August. COVID-19 is far from over for any country.

Remember this is a global crisis

NZ is part of Team Earth fighting COVID-19 internationally. Let’s call this the global response. What other countries do in terms of flattening the curve and containment measures affects us all the way down here in NZ.

No matter what we do, we can still expect economic losses from other countries' activities. Guan et al. model the global supply chain effects of COVID-19. They find the supply chain losses depend on the number of countries imposing containment measures, and the strictness of those measures. Seems obvious but it has an interesting implication. Even countries not directly affected by COVID-19 experience substantial economic losses due to disruption in infected countries. They estimate that NZ would still have a 2.2% value-added GDP loss if COVID-19 was confined to China by a strict two-month lockdown. This cost ramps up as the virus spreads globally and more countries impose restrictions. Of course, this isn't a surprise - we operate in a globalised world whether we like it or not.

The inverse is also true with the lifting of lockdowns being economically beneficial beyond the home country. Lifting lockdowns in major economies (e.g. the United States) could even contribute to GDP growth of 2.5% in their smaller trade partners.

So economic losses from COVID-19 are unavoidable due to spillover. If countries do not flatten the curve, the spillover costs increase as the virus spreads and more countries respond. Containment measures impose costs within a country, but uninfected countries benefit from the reduced transmission. Not having containment measures (or at least flattening the curve) compounds the global economic pain as more countries become infected.

With the solution not belonging to any one country, we have to work together. That’s where entities like the WHO come in, though with their $2.5 billion budget they can’t necessarily do a lot. If one country has a new contagious virus, the right incentives need to be in place to respond with appropriate measures for global benefit.

To lockdown, or not to lockdown, what a difficult question

It hasn’t been possible to completely avoid the economic suffering from COVID-19. The fall in economic activity internationally means that every country is suffering no matter what they did. To an extent, the economics of COVID-19 and the long-run effects are beyond us at this stage. There will continue to be debate as to what the main contributors to the economic crash are, and what the best type of containment is.

The government, population and global responses all played a key role in the COVID-19 crash. Of these, the global response is the most important. Strict lockdown at the start of an outbreak greatly mitigates the global economic impact through the reduced transmission. That’s not the full story, but it’s an important part.

In some ways NZ got lucky. We are already isolated at the bottom of the South Pacific. By the time COVID-19 reached our shores we already had the opportunity to learn about what was happening. Government-mandated containment measures were implemented with the full knowledge that this could get ugly.

COVID-19 will be seen as a watershed moment for government involvement in the economy. Alongside issues like inequality and climate change, COVID-19 highlights problems that are best addressed collectively. What comes next? We will have to wait to find out.

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© Byte Size Story 2020

A New Zealand based politics and economics blog

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