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Why the Corona Virus Recession will be Different to Other Recessions?

Written by B P Scallan – The Da Vinci Institute

Abstract:

This paper describes how shock events such as the coronavirus pandemic changes the course of economic history. It details the mechanism of how the virus spreads requiring a lockdown to contain the spread and which has consequences for the economy but initially only on the supply side. Furthermore, it speaks to how a disruption to supply will cause a different type of recession to previous recessions. A solution is proposed requiring the support of the International monetary Fund and suggests features of the new economy that will emerge from the recovery. It is necessary to envisage what the future might be like, so as to prepare appropriately.

Keywords: coronavirus; recession; change

 

Introduction

The coronavirus which has the technical name SARS-CoV-2 causes the disease COVID-19 which has become a pandemic throughout the world. There is considerable comment in the media of how the coronavirus spreads and what can be done to curtail it. The response measures being taken are a shock to the economy of deep and far-reaching consequence and these shocks cause changes to the trends of economic history.

It is possible that the coronavirus will have an influence on the world economy for 18 months or longer. This will cause a world recession which unlike previous recessions and depressions would have been be initiated by a supply based disruption and not initiated by a financial sector collapse. The paper explores how this will cause the economy to evolve. Modified economic interventions that are different to those used in previous recessions will be required.

Exogenous shocks break past trends

Economics often concerns itself with examining the past in order to forecast the future environment. In analysing the components of an environment Weinshall (Weinshall, 1977) distinguishes between pendulum systems or two-way systems, which alternate between abundance and shortage, and one-way systems which move irrevocably in one direction. Pendulum systems which include systems such as the money supply, interest rates or the business cycle, are endogenous, in that they originate from and exist within the system. One way systems are exogenous, since they originate from without the system and are external factors.

The great economist Joseph Schumpeter (Schumpter, 1939) stressed the importance of external factors writing:

‘Now, it is obvious that the external factors of change are so numerous and important that if we beheld a complete list of them, we might be set wondering whether there was anything left in business fluctuations to be             accounted for in other ways …  In fact, it would be possible to write without            any glaring             absurdity, a history of business fluctuations exclusively in terms      of external factors, and such a history would probably miss a smaller amount          of relevant fact than one which attempts to do without them.’

 

External factors are thus the primary disrupters of trends and otherwise stable conditions. The corona virus pandemic is an extreme disruptor of every individual economy and consequently, of the integrated and globalised world economy. It is the view of the author that the corona virus will cause a global recession, as will be explained below, and this recession will be different to previous recessions, the recovery will be different and how society changes will be different.

The mechanism by which the virus is spread

It is necessary to discuss the epidemiology of the COVID-19 disease as background to the economic assumptions that are made.

Data is needed to understand the pandemic and while the numbers will be constantly changing, the principle remains the same. At the time of writing (31 March 2020), a total of 1326 cases have been officially reported in South Africa as of the previous day. The death total is three. How are these statistics interpreted? There were 709 cases five days previously which means a case growth rate of over 13% per day. This is slower than a few days previously, but the rate will change depending on the level of testing. If left unchecked, at these growth rates, the majority of South Africa’s population will be infected within a short time, possibly 90 days.

The imposition of the shutdown is an exogenous factor to the current growth rate. The shutdown will slow down the number of infections because it reduces the number of uninfected people coming into contact with those people who are contagious or touching new surfaces which have become contagious. The number of new infections that may result from one infected person depends on the incidence of contact with other people. That is why in some countries, such as Australia, meetings of more than two people are restricted.

Analysing the progression of the virus through the South African population is both complex and complicated, in that there are many factors involved, and an understanding may require examination in depth.

The author’s background before studying economics was in chemical engineering and he has tried to think of how the disease spreads in the way of chemical reaction kinetics. It is not the same in that in a nuclear reaction, one neutron making contact with an uranium235 nucleus produces on average 2.43 neutrons, which in turn can collide with other nuclei or escape from the mass of uranium. The original neutron is absorbed in fission products. If the mass is sufficiently large, at or beyond the critical mass, then the neutrons cannot escape and a chain reaction results which causes a nuclear explosion.

A person infected by the virus can infect others by coming into contact with them. Coming into contact means breaking the two metre social distance rule. Unlike the neutron, which is absorbed after making the contact, the infected person can carry on infecting others with no limitation.  Newly infected people can also infect others before any symptoms of infection shows up. (Yong, 2020). This means that the infection can be passed on, unknowingly, many times. The virus infects through stealth.

Going back to the chemical reaction analogy: what speeds up a reaction is the degree of mixing in a reactor. How infected people mix therefore determines the rate of spread of the virus. Attempts have been made to determine how many others one person can infect and some authorities have said two, while others say six.  There is no limit and it depends on the degree of mixing which is done in groupings of people. The larger the group the more explosive is the mixing. One person can infect many and each new infection can in turn infect many more. The smallest group is critical. There is no critical mass number below which it is safe to have meetings. South Africa originally limited the size of meetings to 100 and then, with the lockdown, stopped all meetings. Some countries have limited the maximum size of a meeting to be two people. Funerals are an exception in South Africa and gatherings of 50 are allowed. This is a grave mistake (excusing the pun) particularly if the funeral is of someone who has died from COVID-19.. The risk to the immediate family of the deceased being infected (possibly undetected) and infecting the mourners at the funeral is high. This can undo all the good done by those who are complying with the lockdown at personal cost. The South African government must reverse this decision as it is clearly detrimental to the objective of preventing cross-infection. The funeral can take place with two or three people to bury their dead and the memorial service taking place later when the lockdown is lifted.

The rate of growth in infections is explosive and the way to stop infections is through isolation via lockdowns. People who have survived an infection, even a subclinical infection, develop an immunity and are not carriers of the disease. ‘Herd’ immunity describes the phenomenon that at-risk individuals are protected from infection because they are surrounded by immune individuals and the spread of the virus is thus minimised. Some experts (van Schaik, 2020) estimate that we will only reach herd immunity to COVID-19 when approximately 60% of the population is immune (and remember that immunity is currently only reached by getting the infection as we have no vaccine!). The infection is not only spread by human to human contact, but by surface to human contact. The virus is said to remain infectious for a greater duration than some other viruses on surfaces such as plastic (particularly), stainless steel, cardboard, and, to a lesser extent, on copper. (Van Doremalen & al., 2020). Surely ‘herd immunity’’ will be impaired, if active viruses on surface can also infect people.

Lockdowns do help, as has been shown in Wuhan, Hubei Province, China. There was strict enforcement of the lockdown which is possible in an authoritarian state. The success of the lockdown in Italy has not been as effective is in China, probably due to less compliance. It remains to be seen what the level of compliance will be in South Africa. Even if there is a will to comply, the reality of circumstances of many South Africans will impair compliance. Circumstances include high levels of homelessness, crowded living conditions particularly in informal settlements, non-compliance of social distancing in queues for groceries, and even denial by some that there is a contagious pandemic in South Africa.

A study by Imperial College London (Ferguson, 2020) recommends that lockdowns, or their equivalent to reduce transmissions, will need to be maintained until a vaccine becomes available (potentially 18 months or more). The study predicts that transmission will quickly rebound if interventions are relaxed. Interventions may be relaxed temporarily (maintaining social distancing and disease surveillance) in relative short time windows, but measures will need to be reintroduced if or when case numbers rebound.

Thus, the lockdown, because it will not be absolute, will slow down the spread of the virus but is unlikely to eradicate it completely. It will remain present in our population for the immediate future. It is possible that the lockdown of the South African economy will have to be extended beyond 16 April or repeated if infections start again or continue to rise.

The effects of global lockdowns on the supply side of the economy

 

The consequence of reducing infections via lockdowns is that people do not come together in factories to work. Only service industries which do not depend on human to human contact, such as certain knowledge workers who can still work in isolation, from home or via the internet, can easily continue work. Their workflow will be diminished by the extent that their work is derived from sectors that have been directly affected by the lockdown. Many projects are being put on hold or cancelled, due to the general uncertainty created by the pandemic.

With much of the production activity shut down, the GDP will contract. An estimate from Goldman-Sachs which is widely reported, is that the US economy will contract by 24% in the second quarter of 2020. Similarly, JP Morgan Chase is reported as estimating a 40% decrease in Chinese gross domestic product for the first quarter of 2020. (Kennedy & Bloomberg, 2020)

A feature of globalization that has increasingly occurred over the last decade is the globalization of the supply chains of intermediate manufactured goods. Components, intermediate goods, and subassemblies are made in different countries and move around the world before final assembly, distribution, and sale as final goods. Sometimes goods have had components and subassemblies travel to three, four or more countries in the supply chain before they become final goods. Lockdowns occur in different countries at different times in different parts of the chain. A disruption in one part eventually causes a disruption in all parts, either through non delivery of inputs or cancellation of orders because the next stage cannot be performed.

The cessation of production in China, caused by its shutdown, caused orders to be cancelled for South African suppliers of raw materials such as coal and iron ore. Other trade was stopped by China which banned the import of live animals which dramatically affected the Western Cape’s export of crayfish to China. Trade routes have been disrupted with the ban on international travel. Gold is still an important export for South Africa and South Africa cannot now export gold bullion for physical delivery to the London Bullion Market Association because there are no Johannesburg to London flights and payment can only be made on delivery.

Thus, the immediate effect of the lockdown is a disruption of supply.

The law of markets, also known as Say’s Law after the 19th century classical economist Jean Baptiste Say, is that the ability to demand something is financed by supplying a different good in other words that ‘supply creates its own demand’. As Adam Smith observed the ‘sole purpose of production is consumption’. A supplier producing goods for consumption and sale receives income, which in turn creates demand. Thus, with the reduction of supply there is a reduction of income and then a reduction of demand. Disruption of supply is occurring throughout the world and is the economic cause for the world’s economy contracting and the pending recession or worse depression.

This is different to other downturns resulting by business cycle fluctuations and major recessions caused by disruptions in the financial markets. The great depression of 1929 was caused by a stock market crash which was preceded by excessive speculation funded by equally excessive borrowing and leverage in the purchase of securities (Galbraith, 1971).  Similarly, the global financial crisis of 2008 was caused by excessive leverage of the housing market.

In both these recessions and depressions there was a decline in the value of assets, stocks and shares. This caused a perception of a reduction of wealth which caused a reduction in demand. The manufacturing capacity of the economy remained intact, there was just no demand for the output. The solution was to stimulate the level of demand by government spending and increasing the money supply through quantitative easing.

Not every country engaged in the financial leverage that was the primary cause of both recessions/depressions, yet every country in the world was affected by those primary causes. This is an important difference with the pending recession as the primary cause will exist in every country, if it does not already exist.

What will the economic effects be in South Africa? We have stopped production in all areas other than those classified as essential, such as food production, plants essential to be maintained, distribution, health care, security etc. In the US when production stopped, workers were laid-off and were without pay. In South Africa employees have remained on the payroll even though they are not adding value to the firm. This has caused businesses like Edcon to be fearful of going into business rescue as without revenue from its retail sales, it may not be able to pay its employees’ salaries, as reported on Radio 702. Many smaller businesses are in a similar or worse position, unable to earn revenue but still obliged to pay salaries. The danger of this is that without the massive rescue packages that have been provided to SMEs in the UK and the US, there is a real danger that otherwise good businesses will go into liquidation. Normally it is a business with a poor business model or one that is overly geared that goes into liquidation. This is a purging process of the inefficient in the economy and why in a recovery, an economy can emerge stronger. This recession is in danger of destroying the very productive base of the economy making recovery much harder. The hospitality, restaurant, hotel and tourism industries are particularly at risk. Many B&Bs are small businesses and this infrastructure could be destroyed. Unemployment will rise and a reduction in the number of firms will mean a structural capital contraction of the economy that cannot be reversed by a business cycle.

The primary source of all growth is innovation. (Schumpter, 1939). New innovation will be required in South Africa to start up new businesses to replace those that have been lost. New incentives to encourage innovation will be required as the culture of innovation would have been diminished. Confidence will be down; people’s risk perception will be higher. The level of demand in the economy will be both lower and different to what it was prior to the lockdown.

South Africa is not in a strong financial position to address this crisis. Our debt is no longer investment grade with the latest Moody’s down grade. The government debt to GDP ratio is already high and it will rise even higher. The contraction of the economy will decrease tax revenue from personal income tax, to company tax and VAT collections necessitating more borrowing by the state, than was budgeted for.  This, together with a contracting GDP, will make the debt to GDP ratio even worse.  There is no source of obvious finance open to the government other than borrowing.

The priority for South Africa is first to address the cause and implement the lockdown and get our citizens to practice compliance. Then attention should be focussed on maintaining the productive infrastructure of the country. This is not the civil engineering infrastructure but the business institutional structure. Funding packages similar to those in the US or UK will be necessary, unless an alternative global solution can be implemented.

 

The interrelated nature of the problem and the solution

 

The spread of the pandemic throughout the world has shown how interrelated the world is. All levels of society are affected and in all counties, but not equally, since the poor in a country and poor countries generally are disproportionally impacted. A rich country’s manufacturing bases are being retooled to produce ventilators essential for the care of patients, and personal protection equipment for health workers and the venerable. Poor countries do not have that capacity and supply limitations and export bans prevent them from being imported. Within poor countries, high density living is the norm and this makes social distancing and reducing cross infection that much harder. Poor countries are doubly impacted: probability of greater cross infection and reduced resources to treat the infected.

The slogan ‘we must come together by staying apart’ emphasises the need for everyone to practice social distancing. My health depends on your being healthy and your health depends on my being healthy. If any one person is infectious then everyone who is not immune is at risk.  Philosophically, Martin Buber sums this up with his famous quote: ‘I can never be what I ought to be until you are what you ought to be and you can never be what you ought to be until I am what I ought to be’. This is the interrelated structure of society where everyone is inherently interdependent, needing each other and responsible for one another.

The interdependence does not apply only amongst citizens of one country but amongst nations of the world. If one country has an epidemic of the highly contagious coronavirus, then all other nations who might interact at some stage are at risk. The coronavirus is not a problem of each nation but a problem of all nations together. If any nation has a problem, the problem is not solved for the world. As John Donne wrote:

No man is an island entire of itself;     every man is a piece of the continent, a part of the main;

any man’s death diminishes me, because I am involved in mankind.

And therefore, never send to know for whom the bell tolls;

it tolls for thee.

How can the world, our common home, come up with a global solution, particularly for poor nations which do not have the financial resources or quantitative easing capability of the richer nations. The IMF can increase its lending to these poorer nations, but this will place considerable additional debt burden on nations unable to easily carry hat burden. The burden that they bear is also the burden of other nations as it will be incurred in the fight against the common enemy.

There is an historical precedent from the founding of the United States. In the war of independence, the individual states all incurred debts in their fight against England which was the common enemy. After winning the war and the founder of the United States, Alexander Hamilton who was Secretary of the Treasury had all the debts incurred in fighting the common enemy absorbed by the Federal government. All the states had benefited from the defeat of a common enemy. The cost of fighting the coronavirus should be borne by the world as a whole.

In previous times when the world faced a liquidity crises, the IMF created Special Drawing Rights (“SDR”) which it allocated to the members of the IMF, in an agreed to proportion.  To finance the war against the coronavirus, SDRs should be issued to every nation in proportion to their population which may be used exclusively, and with appropriate governance, for the fight against coronavirus. Finance should not be an inhibitor to the poorer nations to wage this war. This will be global quantitative easing; a type of global modern monetary theory.

Conclusion

 

As the coronavirus recession bottoms, the economy will adopt a new paradigm if it is to recover.

We can only hypothesize what will the form of the new paradigm. Some examples include:

  • We shall be increasingly more of an internet-based society.
  • Meetings will be held via Zoom Meetings, Skype and other platforms such as Facebook’s Portal which converts WhatsApp into a high definition television group to group communication platform with an AI cameraman focusing on who is talking.
  • We shall telecommute rather than physically commute.
  • More shopping will be done on-line with home delivery.
  • Route planning of deliveries will mean that the total transport by the delivery company will be significantly less than the total transport required by individual shoppers, had they shopped, and self-collected.
  • Telecommuting and delivery will reduce the aggregate expenditure on transport in the total economy.
  • Education systems will be changed. Residential universities will lose students to distant learning institutions. There will be more study from home. This need not be a problem since during the bubonic plague in the 17th century a young student, Isaac Newton, was sent home from Cambridge University to practice social distancing and self-isolation (this method of protection against disease has been around for a long time). He used the time away from his professors to be his most creative, developing the mathematics of the calculus, his understanding of optics and light, and the theory of gravity. On his return to Cambridge he was able to formalize his innovative thinking (Brockell, 2020).
  • Many SMEs might have been liquidated as a result of the lockdowns. Thus, there will be a need for an innovative society to create the new firms that will employ those that have lost their jobs.
  • The military-industrial complex could change to a medical-industrial complex with the production of medical support equipment, personal protection equipment (“PPE”) and more importantly other devices to enable the economy to produce goods and services in an environment which avoid the threat of disease.

A realization from the management of the pandemic required recognition that all people share a common home and that while individual liberty and freedom of choice are fundamental values there are certain things that we can do better together. Responding to the coronavirus is one of those things, but our experience may help us realize that there are others, such as climate change.

References

 

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