Understanding Coronanomics: The economic implications of the coronavirus (COVID-19) pandemic

COVID-19 Working Paper 01/20

 

Suborna Barua

 

Release date: 1 April 2020

The full paper is accepted for publication in The Journal of Developing Areas;

A draft version is available as a working paper here: https://www.ssrn.com/abstract=3566477.

 

        The globalization of COVID-19 pandemic and its economic impacts is set to run havoc across all economies in the world, throwing many into recession and possibly economic depression. As the numbers of infected and death cases rise sharply and recovery from the pandemic remains uncertain even in developed countries, evidence of shocks across economies including China, the Europe, and the US are already emerging. The paper provides an overall understanding of the likely macroeconomic shocks of the pandemic, covering economic activities or areas including demand, supply, supply chain, trade, investment, price level, exchange rates, and financial stability and risk, economic growth, and international cooperation.  The paper identifies five broad waves of impacts. 

Figure 1: The possible timeline and span of COVID-19 economic impacts

Wave 1: The immediate impacts are production shutdowns as factories and business are close doors, initial drops in demand as people do not consume non-essential goods, massive disruption in global supply chain as goods cannot move from one place to the other and transports and logistics become restricted due to border closure, and alongside people cannot travel for business and personal purposes.

Wave 2: The effects result a sharp decline in global trade flows for both goods and services. Furthermore, international investment flows come to a halt as people and goods cannot move, businesses remain closed, and investors take a wait and see policy to mitigate uncertainty.

Wave 3: Eventually, each nation sees a deep fall in production and aggregate supply and aggregate demand. A big fall in aggregate demand is mainly driven by fall in demand for non-essential goods and services such as recreations, shopping, and household appliances, etc. However, demand for essential goods such as medicine and food rises during the pandemic. Since in aggregate demand, demand for non-essentials is way larger than that for essentials, the net effect is a sharp fall in aggregate demand. A fall in demand pushes the overall price level down since prices for non-essential fall at a much larger magnitude than price rises of essentials due to higher demand. As business fall depressed demand, people are forced to be laid-off; as businesses keep cutting jobs over a longer period, unemployment begins to rise at an alarming rate. Many businesses may even fail to survive or file for bankruptcy - be it small or large. Failure to survive or generate enough revenue, bank defaults begin to rise and non-performing loans pile up. The financial sector, particularly, lending institutions like banks, would face a massive shock to their financial performance and firm value. 

Wave 4: The combined effect in the long-run of the first three waves will be consistent decline in economic growth or GDP growth. Overall in an economy in the long-run, consumption falls, private investment depresses, government tax revenue falls while expenditure rises through pandemic support and stimulus packages, and exports and imports both fall.   

Wave 5: A fall in GDP growth consistently over a quarter could result in a long-term stagflation or recession or in a worst case a depression, which is complex and difficult to recover quickly. In the long-run, particularly in the when the pandemic is over, all economies focus on recovery and rebuilding of economic fundamentals. This could result a new form or international relationships since all countries are likely to assess how their old friends supported them in the difficult times. Furthermore, global leadership pattern could change as China is likely to have a greater influence over the world economy during the post-pandemic world.

        The pandemic's deep rooted and long-lasting economic damage may take a long time to recover. That recovery requires innovative and differential policy responses. For example, considering that the pandemic is global and all countries are affected, a quick and collaborative policy response at the global or multi-country level should be adopted in addition to individual economy-specific policy measures. And essentially, responses should begin as soon as possible. Most optimistically, the recovery is likely to be 'U' shaped, not a 'V' or an 'L'.