In a Covid-19-induced crisis the usual rules do not applyby Jonathan Portes / March 17, 2020 / Leave a comment
As so often in economics, it’s about supply and demand; and remembering that both matter. The first and most obvious impact of the pandemic will be on supply. The most important input to any economy is labour; and both covid-19, and more significantly the measures taken to contain it, will reduce labour supply. If people are sick, if they’re self-isolating because they think they might be sick, or if they’re looking after vulnerable relatives or children who can’t go to school, then they can’t work. Other measures—closing down travel or theatres—will also reduce the productive capacity of the economy.
All this will reduce GDP by quite a lot; a severe recession seems inevitable. What should policy do?
About the immediate consequences—absolutely nothing. These impacts are the direct result either of covid-19 or of necessary public health measures to reduce its human damage. They are part of the cure. If the result is that GDP falls 2 per cent or 10 per cent next quarter, so be it.
But the indirect impacts are a different matter. If businesses are closed, or lay off workers, incomes will fall; and fear and heightened uncertainty will reduce spending (even if stockpiling leads to a temporary spike in demand for some products). The prospect of mass redundancies in the transport and hospitality sectors may be only days away.
Policy can address this. And it should. The direct disruption to supply from covid-19 will be temporary—the vast majority of us, and the businesses we work in, will be just as productive when this is over as we are now. But the hit to demand could do permanent damage to the economy’s capacity. If businesses—from airlines to pubs—close down, this is likely to reduce output not just temporarily but for a very long time to come. As for workers who lose their jobs, they are likely to be unemployed for a while—and even after that to be reemployed in lower-wage, lower-productivity employment. If we let this happen, the “scarring” effect on the economy could be considerable. But there’s nothing inevitable about it at all—with good policy, there’s no reason we can’t avoid it.
So what can we do? The answer is simple, even if the policies are not. We need to stop firms laying people off and stop them…