The Economics of Coronavirus*

The Economics of Coronavirus*

Currently the world is under the spell of COVID-19, also known as the Corona virus. While the focus is on the health crisis that the virus has caused, there may also be an economic crisis on its way. This blog explains the economic effects of Corona, what should be done to limit economic damage, and the actual policy responses of the Dutch government so far.

The economic effects of Corona

In December 2019 the Corona virus was detected in China, and has by now spread to most countries in the world. After the virus was detected in China, Chinese firms closed in an effort to limit the virus from spreading. Firm closures affected the Chinese (workers are not getting paid, and firms make losses), but also reduced the amount of goods provided in the economy. Since China is a large manufacturer of intermediate goods (i.e. goods that are used as inputs for other goods), this led to a drop in supply. In other words: firms were no longer able to produce what they wanted to, because they were lacking inputs required for production.

Second, a demand shock followed. In order to contain the virus, transportation, hotels, restaurants (and tourism more broadly) suffered, because consumers postponed their consumption. This demand shock hit mostly these (and some other) specific industries the hardest.

After the spread of the virus extended to Europe and North America, more drastic measures were taken in the rest of the world. Urging people who feel sick to quarantine themselves in many countries. On Thursday, 12 March in the Netherlands, people were asked to work from home when possible and to avoid meetings involving large groups of people, and on Sunday, 15 March schools were closed. At this stage, the economic fallout has become large. Since firms are closing (or at least reducing their production) and events are cancelled we see a large reduction in the economy’s supply.

Now also the demand is being affected stronger. Social consumption is discouraged, for example going to bars, restaurants, or other social events. In addition, in uncertain times, spending on durable goods also decreases; for example, people will postpone buying a new car in the coming weeks or even months.

At this point the impact of the economic fallout is largest on small firms and the self-employed, who have little buffer against the loss of income. However, some larger firms (specifically in industries facing large demand shocks, such as the transportation industry) will quickly follow. In addition, the stock market (and price of oil) has gone down. Obviously, those owning stocks are hurt. However, if the stock market is not going to rise anytime soon, we might all suffer. Pension funds, for instance, own stocks; if the returns are low for a long time, we might receive lower retirement benefits.

What has been discussed so far entails the short run effects. However, the most severe economic problems may occur in the long run. Once the health crisis is over, economic activity can be increased again. But whether it does, depends to an important extent on how much consumers are willing to spend. In the case that consumers have little confidence in the economy, they will keep delaying their consumption. This implies that firms will face economic hardship for a longer time.

What should be done?

First, people should be provided with enough incentives to stay home, in case they believe they are sick, in order to limit the spreading of the virus. This means that they should be paid during sick days (and not having to use their personal vacation allowance). Also, the unemployed (who feel sick) should not be stimulated to find work in the coming weeks or even months. Governments can help by setting up a sick leave fund, covering the costs of sick people staying home.

Special attention should be paid to those who are on flexible (for example zero hour) contracts, or those working in the gig economy. These workers are not well protected against income losses. Therefore a special fund for these workers may be worth considering.

The economic focus should also be to avoid permanent firm closures, using short run interventions. Governments could: offer (partial) refunds to firms who need to pay their currently unproductive employees, postpone taxes paid by firms, and offer a guarantee in case firms have difficulties receiving short run loans.

Finally, consumers should be stimulated to keep spending their money. If the virus causes consumers to postpone consumption, this would mean that firms face less demand for their goods, leading to lower demand for labour, leading to fewer salaries being paid, which decreases consumption further. One way to stimulate consumer spending that should be considered is through temporary tax cuts.

The policy responses in the Netherlands

On Thursday, 12 March the government implemented strict rules, these include: no group events containing more than 100 people, and try to work from home if possible. One exception to this were schools. Primary and high school teachers should continue their work. By closing schools, parents who cannot work from home are limited in their abilities to work, leading to even greater loss of economic activity (and loss of productivity of the much needed health care workers). On Sunday 15 March it was decided that schools were also to close, and parents should keep their children home. Parents working in an occupation labeled as vital for the economy were granted an exception, their children could still go to school.

The Dutch government has also implemented policies in order to avoid fallout of small businesses in the short run. These policies include government help in getting short run loans (through guarantees), partial unemployment benefits for 2 to 24 weeks, and postponing tax bills.

The group of workers that is particularly vulnerable for shocks are those who are the first who lose their income when demand in the economy goes down, and are not insured against this loss. Examples of such workers are those employed in the gig economy, or on zero hour contracts. For now there is no concrete plan to help to these vulnerable workers. If the government does not help those to recover some of their lost incomes, then the group of gig and zero hour contract workers may be among the hardest-hit economic Coronavirus victims.

*Part of this blog was initially written for the Economics of Security course in the BA Security Studies at Leiden University.

Max van Lent is an Assistant Professor of Economics at Leiden University. His research expertise is in the field of labor economics and behavioral economics. At the Institute of Security and Global Affairs he teaches the course Economics of Security to undergraduate students.

Image: Photo by Fusion Medical Animation.