At the time of writing, the length of time for social distancing has been of the order of a few weeks. What remains unknown is precisely how long it both needs to and can last. I leave that as an open question that may already be answered by the time you read this book.18
Key Points
1. Pandemics require resolve and quick action to control while minimizing public health and the eventual economic impact. The urgency and need for coordination imply that governments need to adopt policies and allocate resources akin to times of war. This means a suspension of free market forces in favor of command and control approaches.
2. If social distancing aimed at “flattening the curve” is too late, the goal of that policy—to prevent healthcare systems from reaching capacity—will not be achieved. In that situation, governments will need to rapidly expand capacity using wartime protocols such as redirecting private manufacturing facilities to produce medical equipment and using the military to expand hospital capacity.
3. There is a need for price controls on products that have a role in reducing the spread of the infection, as market prices will not allocate those products where there are shortages in an optimal manner.
4. Restrictions on movement will need to be imposed and enforced to ensure proper social distancing in containing COVID-19. Targeted quarantines have high risks associated with them that may undermine their effectiveness unless information about those specifically infected is widely available.
4
This Time It Really Is Different
Recessions are not normally thought of as normal. But normal recessions tend to follow a certain pattern. First, they are preceded by a boom—a sustained period of high growth. Second, this boom gives the financial sector the confidence to innovate in various new ways of managing risk. Too often, however, these are not really new innovations per se but, instead—it is not a stretch to suggest—are just new ways of rationalizing the taking of risk and spreading it around. Third, some people start worrying about whether these new innovations are really innovations but are instead just more risk taking. Those worries are often dismissed by those in the mainstream who point out that, while that may have been the case in the past, this time it really is different, and the financial markets have found a party that will last forever. Fourth, something happens that starts to suggest this isn’t a party anymore. Like Wile E. Coyote, the market realizes they are over a cliff and the party ends in a crash as if gravity is a force that can be defied without self-awareness. And, finally, this leads to a freeze in liquidity—that is, everyone not wanting to do anything but hold onto whatever money they have—which curtails investment, harms the cash flow of businesses, causes bankruptcies, and puts people out of work. The end result of this is an economic mess that the government and central banks try to solve by providing liquidity that went missing and by spending where others stopped, and, after a long period of time (at least for the unemployed), the economy starts up again and there is a boom. Repeat.
Given the regularity of the normal recession narrative, you may wonder how people could think there was something else going on. In hindsight, it all looks like a familiar pattern. At the time, however, there are people who think otherwise. They may class themselves as mavericks who will finally buck a historical trend, or it may be that they are a generation who didn’t live through it before nor have taken or paid attention during their Macroeconomics 101 classes. But it is precisely because no one is really sure who believes what that during the actual cycle, there is uncertainty and noise. Indeed, financial markets have confidence issues all of the time and often manage to act like a recession is coming even when it does not emerge. That is, a financial crisis always precedes a recession, but there are financial crises that also happen without broader “real world” consequences. Such uncertainty is why governments and central banks can be (somewhat) excused when they don’t quite see a recession coming and perhaps act when it is too late.
The COVID-19 pandemic is a real crisis and not a financial crisis born of years of naked hubris on the part of relatively few people. Instead, it has elements of a natural disaster and, surprisingly, as explained below, a national holiday. At the time of this writing, the COVID-19 recession is more of the latter than the former and the hope is to keep it that way. Either way, it is very different from previous recessions—we don’t need hindsight to understand what its causes are. We know exactly what happened. Economic activity is falling because of COVID-19, both its (potential) impact and our policies designed to protect our health from it. From the perspective of economic policy, that yielded something unprecedented: virtually all economists—regardless of how confident or not they were in the economic role of the government—agreed on what we had to do about it.1 We needed to ensure that people got paid or, at the very least, continued to act as if they were going to be paid.
Before explaining why this is so, it is useful to reflect on the natural disaster recession that, in many respects, we are trying to avoid. Such recessions have occurred in the past and they are the worst.
Dark Recessions
Economic activity is usually measured by exchange—that is, people pay money for services and things and one person’s purchases becomes another’s pay. The more we do this, the higher our incomes are. Recessions are a reduction in economic activity. As a consequence, we end up with lower incomes and lower expenditure. As expenditures tend to make us more happy than not, our economic well-being is harmed by recessions.
There are two distinct ways that we can see a reduction in economic activity. First, we can decide that we want to spend less on things. If we do that, then businesses find their demand and sales will drop off; they will be less profitable and, not surprisingly, will want to scale back what they do. Fewer payments mean fewer people are paid. Second, something terrible can befall our ability to produce things that people will buy. If that happens, then, regardless of how much they may want those things, there will be shortages. If there are fewer people around to be paid, there will be fewer payments. Dark recessions are recessions of the second variety.
Natural disasters are a clear cause of dark recessions. A flood, hurricane, or earthquake can hit a region and, in the process, cost lives and destroy productive assets—in particular, buildings and equipment but also infrastructure. Ultimately, we produce things by supplying capital and labor. Natural disasters reduce the availability of both, and, depending on its severity, it can take months or years to restore them. If there is a silver lining here, we can ensure people get paid quickly by employing them in the cleanup and rebuilding process. From the perspective of our national accounts, disaster in reality doesn’t always look like a disaster for the GDP.
The same loss in productive factors arises after wars. During wars there is another story as resources are reallocated to war efforts. Once again, this is a situation where a seeming expansion in economic activity underlies a tragedy.
A pandemic has the elements of a natural disaster except that it is purely focused on people. The fear is that a large share of the population will become sick and a relatively large share might die. From an economic perspective, that means that temporarily, and potentially permanently, we will have fewer workers to produce stuff. We will have a recession or worse but without the potential increase in economic activity that might be generated by rebuilding.