COVID-19 will hit world economy hard. Here’s how.

by Fabius Maximus

Summary: Now that the COVID-19 epidemic is spreading beyond China (while China’s containment efforts are succeeding), let’s look at its likely effects on the world economy. We have to tools to manage them, but they won’t be pretty.

Popping the World's Economic Bubble - Dreamstime-35407897
ID 35407897 © Eduardo Huelin | Dreamstime.

The impact of an epidemic on people’s health is, of course, the most important factor to guide policy-makers. But the economic effects also require attention.

Most obviously, somebody must pay for the required health care, the testing, the quarantines, the drugs, and the vaccines. Putting that burden on individuals means that some will avoid these necessary steps – and spread the disease. Others will pay and reduce spending (or go broke) – which is how recessions become depressions and deflationary spirals. But we have the political machinery available to handle these issues, if we have the will and wit to do so.

The broader macroeconomic effects are both more complex and difficult to manage. For an introduction, I recommend reading “The economic effects of a pandemic” by Simone Wren-Lewis, Emeritus Professor of Economics at Oxford (hat tip to the invaluable daily links at Naked Capitalism). First, I will give my summary. Followed by an excerpt from his article.

What’s coming?

There are three major dimensions of the coming economic shock, although we can now only guess at their varying magnitudes (which will vary greatly among nations).

Direct cost of the epidemic.

The testing, the quarantines, the hospitalizations, the drugs, and the vaccines. The expense could bankruptcy those without excellent insurance. We do not want people avoiding testing, quarantines, or treatment because of the cost – becoming a vector to spread the disease! We could open hospitals to them, and watch many hospitals go broke when the bills are not paid. The public healthcare systems, such as Medicaid, are too slow and inadequate for this.

As problems go, this is almost trivial. Just have the government pay for it. The cost will be a fraction of that of the Virginia-class submarines or the F-35 – and do much more for the defense of America. The processing mechanisms of Medicaid or Medicare can handle this on an emergency basis. It requires only wit and will by our leaders.

Demand shock

Sick people buy fewer goods and services. Nor do people self-quarantining to avoid catching the disease. This could become a severe demand shock to the economy in regions hit hard. It creates ripples out through the economy as businesses cut back hours and purchasing in response to less demand. This is how recessions often start.

READ  Brazilian politician gets the covid-19 vaccine live on TV. Wait.....

If the shock is large enough, people and businesses default on their loans and banks reduce their lending. This creates another economic shock that ripples out through the economy. Unless stopped, it can become debt deflation (see here and here) – the killer of modern economies, the fast-track to a depression. Fast action by the central banks and governments prevented this in 2008, and can again. That means backstopping banks so they neither rapidly foreclose on loans or stop the lifeblood of credit to the economy. That means financial aid to affected households.

As with health care costs, these are tried and proven measures for which the machinery already exists. We need only leaders with the wit and will to use them quickly and on a sufficient scale.

Supply shocks

Sick people don’t work. Neither do people quarantined in their homes, either by the government or in self-preservation. This shuts down businesses, disrupting the global supply chains that drive the world economy. Since China is in many ways the core supply engine for the world, that it is the focal point of the epidemic has many experts concerned. But the rapidly spreading epidemic will break many more chains.

There are no easy solutions for this. There are no precedents for this on a global scale. So this might amplify the demand shocks described above, as businesses close, unemployment rises, and businesses and households default on their loans. It increased the need for fast action by central banks and governments using proven tools.

Simon Wren-Lewis’s analysis

“Let me start with the least important impact from an economic point of view, and that is the fall in production due to workers taking more time off sick. It is least important in part because firms have ways of compensating for this, particularly if illness is spread over the quarter. For example those who have been sick and come back to work can work overtime. This will raise costs and might lead to some temporary inflation, but the central bank should ignore this. …

“School closures can amplify the reduction in labour supply if some workers are forced to take time off to look after children. On the basis of the assumptions we made, if schools close for around 4 weeks that can multiply the GDP impacts above by as much as a factor of 3, and if they close for a whole quarter by twice that. …

“If people start worrying about getting the disease sufficiently to cut back on this social consumption, the economic impact will be more severe than any numbers discussed so far. 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. This is why the biggest impacts on GDP occur when we have people reducing their social consumption in an effort not to get the disease.

“However falls in social consumption do not scale up all scenarios by the same amount, for the simple reason that supply and demand are complimentary. If school closures and people taking more time off work increase the size of the supply shock, the demand shock has less scope to do damage. The largest fall in annual GDP in all the variants we looked at was 6%. …

“If I was running the central bank or government, I would have already started having conversations with banks about not forcing firms into bankruptcy during any pandemic.

“But economics can also influence health outcomes, and not just in terms of NHS resources. For a minority of self-employed workers there will be no sick-pay and those without a financial cushion will be put under stress. One of the concerns as far as the spread of the pandemic is concerned is that workers will not be able to afford to self-isolate if they have the disease. So if I was in government I would be thinking of setting up something like a sick-leave fund that such workers could apply to if they get coronavirus symptoms.

“The government also needs to think about keeping public services and utilities running when workers in those services start falling ill. In fact there are a whole host of things the government should now be doing to prepare for a pandemic. It is at times like these that we really need governments to act fast and think ahead.”


Epidemics, pandemics, recessions, and depressions are normal events. Our systems must be sufficiently robust to withstand them. Our leaders must know and use the tools we have to fight them. The public must support their bold actions – and tolerate the inevitable mistakes (actions can only be too soon/too large or too late/too small).