Although we project a grim set of scenarios in terms of fatalities in our analysis, our view on the economic impact is much more sanguine. Weighting our scenarios by probability, we forecast an average negative 0.2% long-term impact on World GDP due to the COVID-19 pandemic.
To be sure, we expect a much larger impact in the short term (with an average negative 1.5% impact on 2020 World GDP across our scenarios). However, equity valuations on average should be unscathed if our long-term projections on GDP are correct. Therefore, we think a 10%+ fall in global equities since the outbreak began is a gross overreaction.
In the short term, there are many channels through which a pandemic could negatively impact GDP. Below we list some of the channels categorised into "supply-side" and "demand-side." Supply side factors include those which affect the productive capacity of the economy (often referred to as "potential GDP"). Demand side factors are those which affect actual GDP without affecting the productive capacity of the economy.
Key supply-side factors:
- Labour supply would be curtailed by death, illness, quarantining, and preventative leaves of absence. This could come either from government restrictions (for example, mandatory quarantines), or from voluntary worker decision to avoid risk of infection
Businesses could close in at-risk industries to mitigate infection risk for employees and customers alike. Tourism, transportation, retail, and restaurants are possible examples
Regions or countries not directly impacted by the pandemic could see supply chain impact via trading partners hit with the virus
Key Demand-Side Factors:
"Confidence" is the key demand side channel. Confidence is an elusive concept to quantify or model in a precise way, but it undoubtedly is a major demand-side driver of economic activity
Falling consumer confidence could cause lower household consumption
Falling business confidence could cause lower investment
Laid off or temporarily absent workers in affected sectors will likely reduce their short-term consumption, even if workers expect to regain employment in the near future
Short and Long-Term Factors
While all of the factors listed above are serious potential drivers of short-term GDP impact, most of them should abate once the pandemic is over, and therefore they aren't logical contributors to long-term GDP impact.
On the supply side, for example, laid off or absent workers will be able to return to work when the outbreak subsides (with the exception of fatalities). On the demand side, confidence should return quickly, and consumers and businesses will be eager to make up for postponed expenditures.
Some agree short-term impact could be very large, but long-term impact should be minimal. Recent research finds a large short-term GDP impact, but none find a significant long-term impact (even in a very severe scenario).
What the Experts Say
Some of the academic papers we consulted include an explicit long-term model. Australian National University academics Warwick McKibben and Alexandra Sidorenko find that the impact of the pandemic shock on GDP fades to virtually zero by about four years after the pandemic occurs.
Within range of the 0.2% population fatality rate projected in our bear-case scenario, the research projects a short run GDP decrease of 9.3% (Kennedy, 2006), 2% (McKibben, 2006), and 1% (Congressional Budget Office, 2006).
"A primer on the macroeconomic effects of an influenza pandemic", written by Steven Kennedy, Jim Thomson and Petar Vujanovic for the Australian Givernment in 2006, is the clear outlier; this is chiefly because it is the only paper to incorporate confidence effects in the authors' economic model (accounting for 550 basis points of their total projected impact).
We agree with the inclusion of confidence effects, though we think the arbitrary magnitudes chosen in the Kennedy paper (including a 10% hit to household consumption in the first quarter of the pandemic) are too high.