[FAQ] Lasting Economic Consequence of Coronavirus Outbreak

As the COVID19 Pandemic shuts down businesses driving countries into recession, the Harvard Business Review takes a look at the lasting economic impact of the pandemic.

Here’s what lies ahead of us.

The Attacking Point in the Economy

To understand this, we need to examine the transmission mechanism through which the health crisis infects the economy.

If the taxonomy of recessions tells us where the virus likely attacks the economy, transmission channels tell us how the virus takes control of its host.

This is important since it implies different impacts and remedies.

The Transmission Channels

There are three plausible transmission channels:

1. Indirect hit to confidence (wealth effect): A classic transmission of exogenous shocks to the real economy is via financial markets (and more broadly financial conditions) — they become part of the problem. As markets fall and household wealth contracts, household savings rates move up and thus consumption must fall. This effect can be powerful, particularly in advanced economies where household exposure to the equity asset class is high, such as the U.S. That said, it would take both a steep (more bear market than correction) and sustained decline.
2. Direct hit to consumer confidence: While financial market performance and consumer confidence correlate strongly, long-run data also shows that consumer confidence can drop even when markets are up. Covid-19 appears to be a potentially potent direct hit on confidence, keeping consumers at home, weary of discretionary spending, and perhaps pessimistic about the longer term.
3. Supply-side shock: The above two channels are demand shocks, but there is additional transmission risk via supply disruption. As the virus shuts down production and disables critical components of supply chains, gaps turn into problems, production could halt, furloughs and layoffs could occur. There will be huge variability across economies and industries, but taking the U.S. economy as an example, we think it would take quite a prolonged crisis for this to feed through in a significant way. Relative to the demand impact, we see this as secondary.

Recessions are predominantly cyclical, not structural, events. And yet the boundary can be blurred.

To illustrate, the global financial crisis was a (very bad) cyclical event in the U.S., but it had a structural overhang. The economy rebounded, yet household deleveraging is an ongoing secular phenomenon — household willingness (and ability) to borrow is structurally impaired, and the collateral damage, structurally, is that policy makers find it much harder to push the cycle just by managing short-term interest rates today.

COVID19 A Different Economic Legacy

Could Covid-19 create its own structural legacy? History suggests that the global economy after a major crisis like Covid-19 will likely be different in a number of significant ways.

1. Microeconomic legacy: Crises, including epidemics, can spur the adoption of new technologies and business models. The SARS outbreak of 2003 is often credited with the adoption of online shopping among Chinese consumers, accelerating Alibaba’s rise. As schools have closed in Japan and could plausibly close in the U.S. and other markets, could e-learning and e-delivery of education see a breakthrough? Further, have digital efforts in Wuhan to contain the crisis via smart-phone trackers effectively demonstrated a powerful new public health tool?
2. Macroeconomic legacy: Already it looks like the virus will hasten the progress to more decentralized global value chains — essentially the virus adds a biological dimension to the political and institutional forces that have pushed the pre-2016 value chain model into a more fragmented direction.
3. Political legacy: Political ramifications are not to be ruled out, globally, as the virus puts to the test various political systems’ ability to effectively protect their populations. Brittle institutions could be exposed, and political shifts triggered. Depending on its duration and severity, Covid-19 could even shape the U.S. presidential election. At the multilateral level, the crisis could be read as a call to more cooperation or conversely push the bipolar centers of geopolitical power further apart.

 Areas of Actions

The insights from financial markets and the history of analogous shocks can be operationalized as follows:

• Don’t become dependent on projections. Financial markets are currently reflecting great uncertainty. A wide range of scenarios remain plausible and should be explored by companies.
• Don’t allow financial markets gyrations to cloud judgement about the business you lead.
  Focus on consumer confidence signals, trust your own instincts, and know how to leverage your company’s data in calibrating such insights. The impact will not be uniform, and the conclusions will be specific to your industry.
• Plan for the best and prepare for the worst trajectories. Keep in mind that a V-shaped recovery is the plausible scenario conceptually and empirically, but don’t let that insight make you complacent.
• Begin to look past the crisis. What micro or macroeconomic or legacy will Covid-19 have? What opportunities or challenges will arise?
• Consider how you will address the post-crisis world. Can you be part of faster adoption of new technologies, new processes, etc? Can you eventually find advantage in adversity for your company, clients and society?

About the Authors

Martin Reeves is a senior partner and managing director in the San Francisco office of BCG and chairman of the BCG Henderson Institute, BCG’s think tank on management and strategy. He can be reached at reeves.martin@bcg.com.

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Source: Harvard Business Review

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