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A nation must think before it acts.
As the novel coronavirus (COVID-19) rips through America’s biggest cities, its effect is being felt far beyond the over 140,000 Americans who are confirmed infected. The quarantines and lockdowns that are needed to fight the virus’s spread are freezing the economy, too, with unprecedented force and speed. The stock market has sunk a quarter from its peak last month, wiping out three years of gains. Last week, meanwhile, brought news that a record 3.28 million Americans applied for unemployment benefits, the highest number ever recorded. Unemployment is shooting up far faster than it did during the 2008 recession, a sign the economy is headed toward recession. How long is the COVID-19 slump likely to last?
To understand COVID-19’s hit on the economy, consider its effect on different industries. Consumption makes up 70% of America’s gross domestic product (GDP), but consumption has slumped as businesses close and as households hold off on major purchases as they worry about their finances and their jobs. Investment makes up 20% of GDP, but businesses are putting off investment as they wait for clarity on the full cost of COVID-19. Arts, entertainment, recreation, and restaurants constitute 4.2% of GDP. With restaurants and movie theaters closed, this figure will now be closer to zero until the quarantines are lifted. Manufacturing makes up 11% of U.S. GDP, but much of this will be disrupted, too, because global supply chains have been obstructed by factory closures and because companies are shutting down factories in anticipation of reduced demand. Ford and GM, for example, have announced temporary closures of car factories.
As businesses rack up losses due to closures, layoffs have already followed. Small businesses will especially struggle to keep staff on the payroll as their revenue slumps. Countries such as Germany are taking steps to help businesses avoid layoffs, and the United States would be wise to do so as well. The U.S. Congress has passed a massive stimulus bill that provides for hundreds of billions in new spending, expanding unemployment insurance and providing a cash handout to low and middle-income Americans, which should help laid off workers make ends meet until the economy begins to recover. The legislation also provides for $350 billion in “loans” for businesses, targeted at firms with fewer than 500 employees. These loans will be forgiven if firms don’t cut wages or lay off employees—so they function de facto like grants to businesses.
How far off is economic recovery? That depends, in part, on when the virus’s spread can be slowed and businesses can be reopened. President Donald Trump has suggested that the economy will be “raring to go” by mid-April. This looks unlikely. Judging by the progression of the virus in places like Italy, places in full lockdown such as New York are still at least two weeks away from when the COVID-19 deaths will peak. Yet, it is naïve to think that this is the point that life will return to normal. If businesses and restaurants are immediately reopened, then the virus will start spreading again. And some parts of the United States have not yet adopted the lockdowns needed to substantially slow the infection rate. Two months of lockdown looks more likely than two weeks. Most projections by public health experts suggest something similar is necessary to substantially reduce the virus’ spread rate. Italy, the European county that has suffered worst from COVID, has taken a month to reduce the death rate from infections, despite strict quarantines.
The best-case scenario is that the lockdowns bring down the COVID-19 infection rate and that testing capacity continues to expand. Suppose that America’s big cities emerge from their lockdowns later this spring. If so, will the economy pick up where it left off? That is far from guaranteed. Some purchases that were deferred during the quarantine will be made once stores are reopened. Yet, others will never happen.
One key risk is the number of businesses that are forced to close during the lockdowns. The more business closures—and the more layoffs that result—the higher the cost of the crisis will be. Unemployment will increase, and the higher it goes, the less likely consumption is to immediately recover after the lockdowns end.
The other major risk to the economy is that the health crisis is accompanied by a financial crisis. The immediate negative effect of COVID-19 on GDP is likely to be far more substantial than was the 2008 subprime crisis. The length of time that the COVID-19 crisis hangs over the economy will be determined by its financial effects. The 2008 crisis caused many years of slow growth because of the huge financial disruptions that resulted, as banks suffered losses and cut back lending—usually a key driver of growth—as a result.
It is easy to imagine ways that the COVID-19 crisis could have a similar financial effect. Businesses and consumers alike will default on loans. Financial markets are expecting the default rate of large corporations to increase, too. America’s banks are better capitalized today than they were in 2008—so they have more of a cushion to take losses. Yet, as losses pile up, government support may be needed to backstop credit markets again. The lesson of 2008, and of the Great Depression, is that the only thing worse than a bank bailout is a bank run, the costs of which are born not only by banks but by their customers. The Federal Reserve has already stepped in to offer additional liquidity to financial markets, but it may have to do more to keep credit available to companies and individuals.
It is possible to imagine scenarios in which the COVID-19 quarantines are followed by a swift economic recovery. The economy was growing steadily before the virus struck, so there are no other factors pushing. But the longer the shutdowns last, the less likely this becomes. More worrisome is that some state and local governments are only just beginning to take the risk seriously—thereby increasing the likelihood that the coronavirus spreads further, and requires longer shutdowns to bring it under control.