March 23, 2020 1:13PM

Virus Crisis Economic FAQ

1. Why are we so concerned about this virus, which so far (as of mid-March) has killed many fewer people than an ordinary flu?

The key to the answer lies in the words “so far.” The virus seems to spread at a phenomenal rate, with cases doubling more than once a week. If the number of deaths were to double once a week, then starting from about 200 deaths on March 15, by the end of May the total would be 200,000 deaths, which is about ten times the number that we get from ordinary flu.

The Imperial College paper made an extrapolation that warned of the possibility hundreds of thousands of deaths if social distancing were not encouraged.

2. How do differences in testing frequency and reporting practices affect reported spread rates and death rates?

The reported spread rate depends on the actual spread rate and the trend in testing frequency. For example, in the United States, testing ramped up the week of March 16, and the reported spread rate rose above 50 percent per day on some days, but that is probably well above the actual spread rate. It is very difficult to estimate the actual spread rate as long as testing protocols are changing.

Death rates are also very unreliable. Some people have died of the disease without being tested for it, so that they do not count in the virus death statistics.

Deaths occur with a lag so that if the number of cases is increasing, the reported death rate will understate the true death rate. To see this, assume that the true death rate is 1 percent, and death occurs 5 days after someone becomes a “case” by testing positively for the disease. Suppose that on day one there are 100 cases and on day five there are 1000 cases. As of day five, there will be one death (out of the original 100 cases), but dividing this by the number of current cases (1000), we would compute a death rate of 0.1 percent, which is far below the true number.

Other factors will cause the reported death rate to be overstated. Most important, many people who have the disease in mild forms will never be tested and thus will not count as cases. So the death rate relative to the number of reported cases will be high relative to the true death rate.

3. What factors affect actual death rates (not the reported death rates)?

An important factor is the quality of care. There was a relatively low death rate on the Diamond Princess cruise ship, and it is likely because the sick passengers and crew were well cared for. In Italy, the death rate from the virus was modest for a while, but it soared once the health care system became overwhelmed. The countries with the highest death rates appear to be those with the weakest health care systems and/or those whose systems are most overwhelmed by a large caseload. But it is hard to be certain, given the challenges with reporting and calculating death rates accurately.

Age and existing health conditions are other important factors. Death rates for the very young are minimal, and death rates for the very old are high.

Although death rates among otherwise healthy people under age 60 and are low, they are not zero. Deaths of health care workers are particularly worrisome.

We should not treat the death rate as if it is some natural constant. When a large share of the cases is in the elderly population, as in the state of Washington in early March, the death rate will be high. When there are ample human and physical resources to treat patients, the death rate will be lower than otherwise. If new treatment protocols, including pharmaceuticals, prove to be effective, the death rate could plummet.

4. What policies have worked best in reducing the spread rates?

Policies to completely isolate those who have or might have the disease appear to have worked in China and South Korea. This seems to require strict quarantine and extensive surveillance. In South Korea, testing was widespread, as was “tracing and tracking.” When someone is sick, you try to trace back to see who might have made them sick, and you try to track down anyone else who might have come into contact with a sick individual. To do this, the authorities can use data on people’s phones to plot their movements. Presumably, this is not something that Americans are ready to allow.

If only sick people can spread the disease, then isolation of people with obvious symptoms can be effective. But if people who experience no symptoms or mild symptoms can spread the disease, then more general social distancing is required. Apparently, many experts believe that the disease can be spread by people who are not yet severely symptomatic.

5. How is government enforcement of social distancing justified by a difference between private costs and social costs?

The personal cost to me of risking infection is relatively low. Suppose I go to a crowded restaurant. Even if I get infected, I am unlikely to die, particularly if I get good treatment should my case be severe.

But the cumulative social cost of many people deciding to risk infection is high. First, they may infect others who have high risk. Second, as the number of people requiring treatment rises, the capacity of the health care system becomes strained, the quality of treatment falls, and the death rate rises.

Front-line health care workers are particularly inclined to stress the social cost of people risking infection. They see cases of young people requiring ventilators. They see fellow health care workers become sick and even die. They see the limits on supplies of equipment needed to treat patients.

6. How can a short, unpaid vacation for some sectors of the economy have such large ramifications?

Financial obligations don’t sleep. The small business that is temporarily closed and wants to keep its workers still has to make payroll. The individual who is temporarily laid off still has to pay rent and make car payments. The airline whose planes are grounded still has to pay the bank for the loans that it took out to purchase the planes.

Our society is highly levered. Many households have not saved enough to go even a few weeks without a paycheck. Many businesses make heavy use of debt financing and have little cash reserves. Banks deposits are supposed to be riskless and available on demand, even though the assets backing those deposits are risky, long-term loans.

When economic activity is running smoothly, this leverage is efficient. Households can enjoy goods sooner than otherwise by obtaining them on credit. Businesses can expand more by using borrowing than they could if they had to rely on cash flow from profits. Banks and other financial institutions allow households to buy homes, operate small businesses, and start new ventures.

But all this leverage increases fragility and interdependence. When households don’t have cash reserves, a short unpaid vacation means that they cannot pay rent. Then the owner of the apartment building cannot make the payment on its loans. Then the bank does not have the money to pay its depositors unless it forecloses on the apartment building and sells it at a loss, etc. 

In a crisis, everyone tries to reduce their leverage. Households cut back on spending. Banks cut back on lending. Economic activity collapses.

7. What are the long-term economic consequences of this crisis?

Behavior will change, and economic activity will alter as a result. People who are considering going on a cruise or flying overseas will be more aware of the risk of contracting an illness, and this will reduce demand. People involved in health care systems will be more aware of the risk of running into a surge in demand, and they will try to expand capacity.

People will become more facile at undertaking work, education, and conferences remotely. Businesses that help foster remote interaction will expand. Businesses that are built around large conferences and meetings will shrink.

As businesses develop supply chains, they may become less concerned with maximizing efficiency and a bit more concerned with ensuring robustness. They may prefer sources with more redundancy rather than sources that minimize cost.

An open question concerns what will happen with leverage. The financial crisis of 2008 caused some de-leveraging in the short term. But households and businesses soon got back to operating with high levels of debt and low margins of safety. Perhaps this time people will be more traumatized than they were in 2008. Perhaps this time government authorities will not be as sanguine about rising dependence on credit in the economy.

8. Why aren’t policymakers taking into account the economic cost of closing restaurants and shutting down other forms of economic activity?

This question implicitly assumes that the alternative of allowing all businesses to operate would be costless. That is, it assumes that we could avoid most of the cost of this crisis if we did not “panic.”

In fact, even if the government does nothing, many individuals and businesses will curtail their activities, based on what they know about the virus. Many private actors were ahead of the government in canceling travel and conferences. The economic costs were already going to be significant, even without government advice or mandates.

More important, an alternative strategy of allowing or encouraging ordinary economic activity could prove even more costly in the long run. One can imagine a scenario in which the health care system gets overwhelmed, causing many people to die who otherwise would not, both from the virus and from other treatable illnesses. There could emerge a social climate in which people fear and suspect strangers. This low-trust social climate would itself hinder ordinary economic transactions.

There is no way to avoid having the economy take a major hit from the crisis. Without a doubt, some of the policy responses will make things worse than would be the case otherwise, and others will make things better. It will be difficult to determine which is which, both in real-time and in hindsight.

9. What about fiscal and monetary stimulus?

I am skeptical about both. Conventional monetary stimulus involves the Fed paying for financial instruments with money that it creates at the stroke of a pen. It’s a subtle way of manipulating rates of return in financial markets. That tool now seems to me beside the point, sort of like the steering mechanism on the Titanic after it already hit the iceberg.

Instead, I think we need a lender of last resort. I have suggested giving households and firms government-backed overdraft protection. Here is further elaboration.

Fiscal stimulus means the government taking money out of someone else’s pocket to give it to you. By someone else I mean a future taxpayer. The future taxpayer may face an explicit tax bill, or that taxpayer may end up paying via the “inflation tax:” giving up some real resource in exchange for government-issued money that is going to shrink in purchasing power.

Fiscal stimulus works because you need to pay your bills today. You don’t care about the future taxpayer. The politicians sure don’t.

As the recipient of the government payment, it looks like you are getting a gift, as opposed to the overdraft privilege or credit line. If you borrow using a credit line, you know you’re supposed to pay it back. But it doesn’t look like you have to pay back your gift. Instead, the person who pays back your gift is the future taxpayer. That future taxpayer could turn out to be you, but you won’t think about it that way.

The political lobbying for these gifts will be intense. I am cynical enough to believe that whatever you and I receive will be but a fig leaf to cover up more extravagant gifts for special-interest constituents. One of the big reasons I prefer the credit-line approach is that interest groups won’t fight as hard for money if they know they will have to pay it back.

[Cross-posted from ArnoldKling.com]