What does the coronavirus outbreak mean for the global economy?

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The spread of the new coronavirus Covid-19 has serious economic consequences beyond the high number of diseases and deaths. The strong international interconnection between countries can lead to the types of economic consequences, now seen in China, to spread worldwide. In this blog post, we tease out the different effects.

1. Economic Demand effects of an infectious disease

A rapidly spreading infectious disease initially has a dampening effect on demand in the regions where the disease occurs. For fear of infection, people avoid shops in city centers and restrict their consumption. They avoid visiting restaurants, cinemas, theatres, leisure parks, major events (concerts, sporting events, trade fairs, etc.) and cancel holiday trips. Such demand drops are particularly serious when government authorities completely cancel major events – as is the case in Italy.

Suppliers of products and services affected by the drop in demand will lose sales. Companies react to shortfalls in demand by reducing their production. Economic activities and employment decline. As a result, gross domestic product (GDP) shrinks.

2. Economic Supply effects of an infectious disease

Human labor continues to be a basic requirement for economic production processes. Rapidly spreading infectious lead to loss of manpower and reduce the production capacities of . This loss can be temporary or – in case of death – permanent. Even healthy employees do not appear at workplaces for fear of infection.

If there is no replacement for the absent workers, the effected companies must reduce or even stop production. The GDP of the economy will continue to decline.

3. International effects of an infectious disease

The economic impact of an outbreak of coronavirus, as outlined so far relates to the region where this infectious disease occurs. The spread of Covid-19 in China has consequences for the world economy because of economic globalization. Again, a distinction must be made between demand and supply effects (see Fig. 1):

• Demand effects of China’s economic weakness: If China’s GDP and incomes fall, China imports fewer goods, services, and raw materials from the rest of the world. Outside of China, production, employment, and GDP fall due to decline in demand.

• Supply effects of a decline in production in China: If production in China declines or comes to a standstill, companies in the rest of the world no longer receive the inputs previously received from China. This is particularly problematic for companies that have no substitutes for Chinese inputs. In extreme cases, this could mean that companies outside China have to stop production – this is already happening as firms in China have at least partly shut down production.

The spillover effects on the rest of the world are serious in the event of an epidemic China because China is now the second-largest economy in the world if economic power measured in US dollars. Taking, purchasing power into account if GDP is expressed in US dollar purchasing power parity, China has y been the world’s largest economy since 2014 (see Fig. 2).

As a result, China’s importance as a buyer of goods from the rest of the world has grown rapidly in recent years. In 1990, Chinese import demand for goods was only 1.5 percent of global import demand. By 2018 it was already 10.8 percent. This makes China the world’s second-largest importer of goods (see Figure 3).

Globalization can accelerate the spread of infection worldwide

If the Covid-19 coronavirus were to spread across countries and continents and become a pandemic, we could expect further impacts on the global economy. The danger of such a spread increases with the development of international mobility and interconnectedness, i.e., globalization. Long-distance air travel accelerates the spread of infectious diseases.

All economic effects described above would then occur worldwide and thus curb global growth.

Economic effects of a global pandemic cannot be reliably predicted

The expected effects of coronavirus cannot be quantified reliably. There are too many uncertainties. To name just the most important:

• How long will this epidemic last? How far does its regional spread go?
• How many people are infected?
• How long will they remain ill?
• How many people die?
• Is it possible to replace workers who are absent due to illness?
• Can intermediate inputs that are no longer available due to production losses be replaced by intermediate inputs from other companies?
• To what extent are the global value chains affected?

Perhaps the greatest threat to global economic development comes from the psychological effect. In addition to the question of how many workers stay away from their workplace for fear of infection, the main problem is the restriction of consumption. If a large number of consumers limit their consumption to purchase of daily necessities, there will be a considerable drop in demand. If companies fear such a collapse in demand, they will limit their investments. Fears of an economic downturn can lead to decisions that actually cause the downturn (see Fig. 4).

Because of these enormous uncertainties, simulations of the potential economic impact of a global pandemic work with various assumptions and several scenarios. The resulting potential damage is correspondingly broad.

Even estimates of the economic impact of past epidemics cannot be precisely quantified. Here is just one example: the SARS epidemic that broke out in China in November 2002 spread to a total of 28 countries. According to official figures, it resulted in almost 8,100 cases of illness and 774 deaths. Estimates of the associated loss of economic output in Asia amount to 12 to 18 billion US dollars (see Wishnick 2010). This is quite a wide .

What should we fear now?

Due to the enormous uncertainties, it is still far too early to be able to make a reliable prognosis about the economic effects of coronavirus. At least Kristalina Georgieva, Managing Director of the International Monetary Fund (IMF), dared to make a cautious forecast at the G20 Finance Ministers and Central Bank Governors on February 22nd:

“In our current baseline scenario, announced policies are implemented, and China’s economy would return to normal in the second quarter. As a result, the impact on the world economy would be relatively minor and short-lived. In this scenario, 2020 growth for China would be 5.6 percent. This is 0.4 percentage points lower than the January WEO Update. Global growth would be about 0.1 percentage points lower “.

By now, it is already quite unrealistic that this estimate will hold. Due to the rapid spread of Covid-19, panic reactions as shown in Figure 4 are likely to be on their way by simply considering the development of stock markets during the past few days. This could cause a global recession.

Literature:

Wishnick, Elizabeth: “Dilemmas of securitization and health risk management in the People’s Republic of China: the cases of SARS and avian influenza, “Health Policy and Planning, Volume 25, Issue 6, November 2010, Pages 454–.