With smart policy, a temporary collapse in GDP doesn’t have to cause great human suffering
The “social distancing” measures needed to slow the spread of the coronavirus clearly reduce economic activity. A growing meme in recent days argues that this reduction might be so damaging that it would be a societal benefit to end the social distancing measures shortly and try to return to normal economic activity.
This is extraordinarily risky from a public health perspective—the potential deaths caused by a premature end to social distancing measures—without exaggeration—could reach the millions.
Further, a scenario that saw this many deaths would also see tens of millions of workers falling so ill they would be unable to work for extended periods. This would cause an economic shock of its own.
Finally, and most fundamentally, this view that terrible (but generally unspecified) economic damage will inevitably occur due to the recent public health measures undertaken represents a profound misunderstanding of how the economy works, and how smart policy measures can neutralize this type of trade-off.
To see why, consider a quick thought experiment.
Recently there have been sensible calls made by people on social media for those households lucky enough to retain income during the crisis to continue paying service workers like housecleaners, even if their work cannot be done for public health reasons.
Let’s imagine we extended the same (compassionate) logic to all services that couldn’t be consumed during the downturn due to social distancing. So those who would have gone to restaurants in the next three months still send their money to those restaurants, and those who would have flown across the country and stayed in a hotel still sent the money they would have spent to airlines and lodging companies. Say further that in exchange for sending these payments even without services being provided, the businesses receiving them agreed to pay their workers the exact same amount they were paying them before.
In this scenario, the wages of workers in shut-down sectors would be held harmless and they would have the resources they needed to keep living. They could also maintain consumption spending in those sectors outside the shut-down parts of the economy and hence keep the coronavirus shock from propagating outside of the sectors directly affected by social distancing.
If we could somehow pull off this coordinated scheme of social solidarity, would the economic shock be completely avoided? Not at all. Gross domestic product (GDP) would still absolutely crater.
Why? GDP measures the amount of final goods and services produced and sold. In our scenario, households continue to transfer money to the workers and businesses in the shut-down sectors of the economy, but they don’t receive any goods or services in exchange because none are being produced.
But the economic damage would be just this: paying money for restaurant meals and hotels and flights without actually getting to enjoy them. This is unpleasant, for sure—as I said, eating in restaurants and traveling are fun things to do.
But this clearly doesn’t sound near-dramatic enough to bolster arguments that the economic damage done by shutting down sectors of the economy to stop the spread of coronavirus is so large it justifies quickly reopening and flirting with the death of literally millions, right?
Obviously the strategy of holding workers in shut-down sectors harmless in the face of this shock would be impossible to undertake if we just relied on private altruism.
Thankfully, we don’t have to rely on private altruism. We already have a system in place to transfer money to families facing economic distress from families that are doing okay—taxes and transfer programs (unemployment insurance, most notably). Granted, our current welfare state is too stingy and too patchy in general, but it can be changed, and lots of these changes can happen on the fly. The CARES Act, for example, makes a number of excellent changes to the UI system that will make it far more useful in implementing just the kind of “hold workers harmless” strategy we’re discussing here.
And it turns out that we can do even better than this. In the thought experiment where still-employed workers continued sending money to businesses and workers in shut-down sectors without receiving goods and services in return, there was no way for the still-employed to boost their private savings and stockpile pent-up demand that could supercharge a recovery once the public health all-clear was sounded. But if we use public debt to finance the income flows to laid-off workers and their families, this means that all the money not being spent by still-employed workers in the shut-down sectors is just building up their private savings, and they will have extra resources to spend once the economy fully opens back up for business.
Even in the most staid textbook presentations of public debt, this kind of consumption-smoothing across time is exactly why debt exists and is useful. In the macroeconomic environment that existed even before the coronavirus shock—when private savings were far in excess of firms’ desires to expand their production capacity and hence interest rates and inflationary pressures were already historically low—this extra public debt taken on to buffer the coronavirus shock is either free or actually just increases societal income and production.
Are there complications to this super-stylized analysis? Of course. The effects of the coronavirus on trading partners is affecting supply chains and imposing a supply shock on the economy. But supply shocks are much less damaging than demand shocks now. And won’t the huge stock market declines of recent weeks put negative pressure on spending through “wealth effects”? Sure, but smart policy that addresses the problems noted above will help the stock market bounce back that much faster.
If the extremely widespread social distancing measures of recent weeks are temporary, any failure to see a rapid recovery in economic activity will be entirely because of an inadequate policy response. The stingier we are with providing aid to workers who are laid off due to social distancing measures, the more this initial coronavirus shock will spread to other sectors of the economy, and the more help in the future will be needed to reboot the economy. But a very large temporary fall in GDP does not have to translate into human carnage, and a very quick bounceback from this type of fall is possible if policymakers don’t fumble this economic recovery from the coronavirus shock as badly as they have so far fumbled the public health response.