Corona Economics
In the first quarter of 2020, the world got turned upside down by something that is so small you can not see it without a microscope. The thing I am talking about is called “coronavirus” and it disrupted nearly every aspect of our day-to-day lives.
By the time I am writing this, the “coronavirus disease 2019”, or short COVID-19, already killed more than 40,000 people worldwide.
Apart from the huge impact the virus has on our private lives, it also heavily disrupts the world’s economy and leads to a hitherto doubtful future. In the following pages, you will learn more about the coronavirus’ impact on the global economy and how it compares to past crises.
Economic Consequences
The most obvious economic consequences of COVID-19 we can see right now are shifts in demand and supply for certain goods or services as well as a huge amount of externalities that affect both companies and private households as well as the world population as a whole. Furthermore, we can see a heavy impact on the stock market, leading to sharp price losses and a negative market sentiment. These impacts, however, can be clustered in two distinct categories that policy has to address: scale effects and composition effects. We will come to those later. First, let us have a look on how these impacts affect the private households and companies worldwide.
Private Households
As described earlier, the coronavirus crisis and the according policy responses created considerable externalities, meaning costs or benefits for the whole society. Social Distancing, for example, causes the private costs of limiting individual freedom while also contributing the social benefit of lowering the risk of infection. So, by limiting our individual freedom, we create on external benefit for the society we live in. Admittedly, those limitations are not always autonomous decisions or acts of civil responsibility as mobility restrictions and closings are policy measures taken by a lot of countries and regions — but the effect remains the same. The same is true for medical testing: having a cotton swab stuck swiped across the depths of your throat or nasal septum definitely counts as private costs, while it creates the external benefit for the society.
The huge demand shifts resulting from both social distancing and mobility restrictions also affect private households. Increased financial pressure on many industries leads to both increased layoffs and reduced hires which in turn leads to lower income for the affected private households. Also, they have to cope with the shortage of hoarded and panic-bought goods, like soap or toilet paper.
Even if it is not a major consequence for private households, it should also be mentioned that the drop in asset prices could potentially affect the households, as their savings are sometimes directly but at least indirectly connected to the stock market. Just think of all the pension funds that are invested in stock market shares or corporate bonds.
Companies
In contrary to the private households, most companies aren’t really affected by the externalities resulting from COVID-19 measures. Only the pharmaceutical industry could potentially be affected by the external benefits as a lot of tax money and inventions are invested in their industry in order to accelerate the development of a vaccine.
The shifts in demand and supply, however, affect the companies heavily. The extremely high contraction in demand for certain services or goods lowers the profits and increases debt for companies like cinemas, hotels, restaurants, airlines or similar kinds of businesses that are directly affected by mobility restrictions, social distancing and other precautionary measures. This results not only in the above mentioned layoffs and reduced hires but also in increasing cases of bankruptcy across these companies. Surely there are some companies that benefit from the demand shift, such as producers of sanitizers, masks or the healthcare industry as a whole — but their short-term benefit does not offset an economy’s long-term losses created by the above mentioned demand contractions. Some companies may also profit from the short-term growth in demand for (especially canned) groceries resulting from hoarding and panic-buying, but also this doesn’t offset the occurring problems.
Apart from the shifts in demand, companies also face challenges and problems resulting from the shifts in supply. Increased employee absence and trade or mobility restrictions for certain regions directly lower the supply of workforce, certain raw materials and outsourced components or services.
The stock market mirrors the negative expectations of future profitability for most companies.
Stock market indexes like the German DAX30 [Image 1.a] or the US-American Dow Jones [Image 1.b] are decreasing as the included company assets suffer from the consequences of the coronavirus. However, there are certain stocks that benefit from the circumstances, like Zoom Video Communications [Image 1.c], a platform for easy video calls that is used more than ever before because of the increase of remote workers and video conferences.
Comparison with the global financial crisis 2008
The year 2007 marked the beginning of the global financial crisis which peaked 2008 with the collapse of the US-American lending institution Lehman Brothers. It is known as the “most painful global economic downturn since the Wall Street Crash of 1929” and lead to a global output contraction of 1.8%. Millions of people worldwide lost their jobs or even their homes because of this financial collapse which resulted from foul subprime loans and the housing bubble.
While it is true, that the economic shock that results from the coronavirus is comparable to some aspects of the global financial crisis, there are also big differences and circumstances that have to be taken into account.
According to the news agency Bloomberg, the coronavirus shock could cost the global economy 2.7 trillion USD — the UN trade agency even speaks of only 1 trillion USD in total. However, compared to the GDP of the world’s most advanced economies, that number is not really that big.
For example, according to the IMF, in 2019 Germany’s GDP was over 3.8 trillion USD while that of the USA amounted to over 21 trillion USD. So, assuming that the rate on infections nearly reached its peak by now, it is very unlikely that the coronavirus shock could also lead to a contraction of the global output as its costs are still moderate compared to the global financial crisis which, according the U.S. government, amounted to over 20 trillion USD.
Furthermore, the coronavirus shock directly impacts on completely different industries and values as the financial crisis of 2008 did. Whilst the subprime crisis was extremely noticeable in the financial sector and the housing market, the coronavirus shock applies most of the pressure to mobility-related industries like aviation or tourism.
According to Ben May, director of global macro research at Oxford Economics, the coronavirus just created a temporary shock to the global economy and “the money that you didn’t spend today will […] be spent in the future unless something dramatic changes…”.
So, comparing the two crises with each other, it is quickly noticeable that each has completely different traits that require different actions. The estimated costs of the coronavirus shock are low compared to those created by the global financial crisis which in turn implies that the current shock situation resembles a temporary state that will most likely recuperate in the following months.
However, we do not yet know the further consequences resulting from the coronavirus shock. A huge amount of the global financial crisis’ costs resulted from bailout payments to distressed banks — and that is something that currently could also happen to heavily affected businesses, such as Lufthansa, a generally well-funded company, that already considers to request state aid.
By now, no one is able to say how badly our economy will be damaged by the shock or whether it will be worse than the global financial crisis. The above mentioned arguments and numbers look positive but are not carved in stone and could change every day. There are certain tipping points, such as the bailouts of airlines, that can potentially flip the whole outlook.
Economic Policy responses
Now that we know more about the coronavirus shock and its consequences, let us have a closer look on how the German or European monetary or fiscal policy can solve the occurring problems.
Soforthilfe Corona
Germany has already applied fiscal policy measures to support the domestic companies. One of them is the so-called „Soforthilfe Corona“ program. It ensures financial aid for small businesses, freelancers and self-employed workers with German residence whose business is threatened by the coronavirus shock. To ensure that the aid is not given to companies that were already in the red before the shock, the government sights the financial documents and evidences of every applicant. The aid is only given to those companies and businesses whose revenues will not be enough to cover their business-related liabilities for the next three months. The amount of financial aid is staggered as follows:
- companies with up to 5 full-time-employees: € 9,000.00
- companies with up to 10 full-time-employees: € 15,000.00
The application is possible until May, 31st of 2020 and applicants who lie about their financial data or business situation will be punished.
I think that this is very good measure, as the wealth of the German nations was created by small- and mid-cap companies. Those companies, however, are often too small to become part of a rescue fund or buyout program, which causes existential threats for them. Through the “Soforthilfe Corona” program, the government ensures a minimal basis of existence for them. According to the German Federal Statistical Office, nearly 90% of German businesses employ less than ten employees — which makes their existence crucial for Germany.
Pandemic Emergency Purchase Programme (PEPP)
As Germany is part of the European Monetary Union and uses the Euro, it is under the European Central Bank’s (ECB) umbrella. The ECB recently announced a new monetary policy measure to tackle the coronavirus shock, named “Pandemic Emergency Purchase Programme” or short PEPP.
PEPP’s goal is to flood the currently suffering market with new money to dampen the shock’s economic consequences. To achieve this, the ECB purchase bonds in all security categories that are already permitted in their existing purchasing program extended by corporate bonds outside the financial sector. Eligible for purchase are all bonds that are issued by companies with sufficient credit quality.
A total of 750 billion euros is available for the bond program — and this amount will be increased if necessary. Through a special crisis decision, the central bank is allowed to be more flexible as usual when buying bonds and will make use of that circumstances “as much as necessary and for as long as necessary” according to ECB president Christine Lagarde.
Through the transmission mechanism of monetary policy, those financial terms are expected by the government to influence not only the companies but also the private households.
Personally, I am not a big fan of that program. Normally, if a bond carries higher risks it will result in a higher interest to compensate the investor for his risk-taking. Through their guaranteed bond purchases, the ECB already messed up the principles in the past, leading to Italian state bonds with high risks and low interest rates. The PEPP could increase the appearance of such anomalies exponentially, leading to confused and diluted financial markets — which is not really what we need in such hard times.
Also, the loosened bond restrictions allow the ECB to buy extremely risky securities, like Greek government bonds, that are not allowed in their regular bond purchase program.
By lowering the entry barriers for untrustworthy bonds and debtors, the ECB could be misused for state financing, which is not only not its purpose but forbidden.
Possible policy measures
If I was the government, I would either mandate or subsidize the production of face masks. It may seem like a minor objective right now — but face masks are crucial for a containment of the virus and therefore the whole crisis. Right now, it’s not easy to get masks in Germany and even less easy to decide if you should buy one, as healthcare institutions are heavily in need for them. Therefore, a lot of state authorities advised people to stop buying masks in order to ensure their supply for the healthcare industry.
However, there is evidence that masks help prevent viral infections like the current pandemic. A study of community transmission in Beijing revealed, that during the 2003 SARS epidemic “consistently wearing a mask in public was associated with a 70% reduction in the risk of catching SARS.”
The logical conclusion of that evidence is that we need more face masks. It should be a clear goal of the government to encourage and increase the production of these through every fiscal measurement available.
Conclusion
The coronavirus shock is a serious threat for the global economy and should not be treated lightly by anyone.
The bad news is that we can neither predict the future development of this crisis nor foresee its consequences and therefore have to be steeled for almost everything.
The good news is that both monetary and fiscal policy measures are already applied to support our economy in those hard times and especially smaller businesses are secured through the “Coronavirus Soforthilfe” instead of being left alone.
Furthermore, a huge increase in solidarity is noticeable. First off, it may seem boring for you to stay at home all day long and avoid social contact — but if you think of the bigger picture and the external benefits you are contributing to while staying at home, you are able and allowed to think of yourself as one of the main factors for saving the global economy and — even more important — other people’s lives. Thank you, you’re great!
