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Conceptual Framework

The impact of a pandemic can be evaluated in terms of the loss of life and other human costs, the economic impact, and the social and political implications. These impacts are interrelated. Here we focus on the economic costs, and specifically the reduction in GDP resulting from a pandemic. In doing so, we assume no serious disruption to social relations and social order. A breakdown in social order could be expected to accentuate the economic impact of a pandemic and disrupt the recovery.

The effect of a pandemic will occur in four stages …

The impact on GDP growth can be broken down into four stages: the anticipation stage; the direct impact stage when the pandemic occurs; the recovery from the impact stage; and the fourth stage is the long term effect. If a pandemic has multiple waves of infection the distinction between these stages will be less clear than for a pandemic that occurs in a single wave.

This framework could be used to evaluate the impact of most exogenous shocks to an economy’s GDP growth. The four stages would however vary according to the type of shock. For example, climate shocks in New Zealand tend to impact through primary production and electricity generation. Furthermore, they tend to come with less warning and any anticipatory behaviour would likely be built into normal institutional arrangements and behaviour. Terms of trade shocks come through relative price changes and can be anticipated if there is for example a systematic relationship between world business cycles and commodity prices. Modelling these types of shocks is somewhat easier because they are recurring and can be estimated statistically using historical data.[9]

… the anticipatory stage …

The anticipatory stage occurs because pandemics typically give warning signs. As the editorial in Nature recently stated “The maths of epidemiology says that pandemics are like fault lines: they inevitably give. But unlike earthquakes, pandemics tend to give warning signs, and all the alerts from Asia are now flashing red” (Nature Editorial 2005).

This stage involves households preparing for medical shortages, and hoarding food and other supplies to overcome potential difficulties in safely accessing them during a pandemic. Businesses normally reliant on “just-in-time” supply chains and overseas supplies may decide to build inventories in anticipation of supply shortages or seek alternative sources. To the extent supplies are produced or have value-added domestically, this behaviour would raise domestic demand and GDP. This impact would be accentuated if the likelihood of a pandemic increased. An increase in imports during this period may increase the trade deficit, but this may be offset by similar anticipatory behaviour in other countries. There is also the prospect of world consumer demand substituting away from poultry to demand for New Zealand’s proteins, lamb, beef and dairy products.

Anticipatory behaviour may also have a negative impact on GDP if the expectation of a pandemic caused consumer and business confidence about future income growth and future sales to decline. If an outbreak of pandemic influenza occurs in another country, firms may defer investment until after a pandemic has run its course.

… the direct impact …

The second stage involves the direct impact of the pandemic occurring in New Zealand. During this stage the impact on the economy will come through both the supply side and the demand side. On the supply side the output of the economy will be reduced as workers stay home sick or afraid, businesses close for health reasons, and the supply of intermediate inputs through international trade is disrupted. On the demand side the economy will suffer reduced domestic consumer demand and reduced demand for exports due to lower domestic and world incomes during the pandemic and also because of “social distancing” resulting from health concerns. In particular, service industries, including tourism and education services, will be acutely affected as people avoid gathering in public or leaving their homes. For some parts of the economy, such as the health sector, demand may increase, but we expect these effects to be small in comparison to the aggregate reduction in demand for goods and services.

Overall these demand side and supply side reactions will cause a reduction in the rate of employment and production, and hence GDP. In the short term there would also be considerable uncertainty about future asset values and reduced cash flow for firms and households. The threat to population growth would likely impact adversely on the housing market. These factors could put pressure on financial institutions and could accentuate the initial impact. The IMF also cautions that “aside from sharp changes in asset prices, operational risks constitute the greatest challenge to the global financial system in the event of a severe pandemic” (International Monetary Fund 2006). The IMF stresses the need for contingency planning by financial institutions to ensure their proper functioning in the face of high worker absenteeism. Exchange rate and interest rate changes could help ameliorate the initial impact effects, as could fiscal policy.

… the recovery …

The third stage is the transition back to the long run potential output of the economy after the pandemic has run its course. The speed and nature of the recovery is very uncertain due to the lack of information about the recovery from past severe pandemics. The recovery path will depend crucially on a number of unknowns. In particular, it will depend on the reactions of business and consumer confidence, and the effects on consumer demand and business investment. It will also depend on how asset prices and household wealth are affected, the reaction of the global economy, the reaction of exchange and interest rates, and changes to expected population dynamics.

The way the pandemic affects wealth will depend on how resilient the housing and financial markets are to the initial shock. If a large reduction in wealth were to occur due to a market collapse, this would be felt for several years in reduced consumer demand. Furthermore, the recovery of New Zealand’s tradable goods and services sector will be crucially influenced by the how badly the rest of the world was initially affected, and the length of time international demand takes to recover.

… and the long term impact.

The fourth stage is the long term impact on the economy and the rate of GDP growth. This long-term effect will depend on the pandemic’s impact on labour force growth and on labour productivity growth. In the medium term any drop in population will reduce the potential output of the economy. But it is uncertain just how a pandemic will affect future population dynamics and labour force growth, and therefore whether the initial decline in potential would be offset by future fertility growth. A pandemic that has particularly high mortality rates for the 20-40 age group, which was the case in 1918, is likely to negatively affect population fertility rates (Brainerd and Siegler 2003).

The impact on labour productivity is also uncertain. A study by Almond (2005) of the impact of the 1918 pandemic showed those in utero during the pandemic displayed, in childhood and adult life, reduced educational attainment, increased rates of physical disability, lower income, lower socioeconomic status and accelerated mortality. This suggests that a pandemic could have adverse effects on future labour productivity. On the other hand, a reduction in population, other things equal, could result in an increase in the level of physical capital per worker if investment was sustained. This capital deepening effect may raise labour productivity. The reduction in population may also impact on aggregate savings. All these potential reactions are uncertain and hence the long term growth path is also uncertain.

Figure 1 shows the various stages involved in the pandemic shock. In this figure the long-run GDP path Y is the path without a pandemic shock. Because of the pandemic, during the impact stage there is an initial reduction in output from the economy’s long-run path. Over time, the economy recovers back to the long-run potential path. However, we assume in our estimations that the potential long-run output is now lower due to death, shown by the long-run GDP path Y* (assuming labour productivity growth remains unchanged). In Figure 1 we have shown the anticipatory stage to have a positive effect on GDP, but as noted above this could either be positive or negative depending on the extent that confidence is decreased by an impending pandemic.

Figure 1: Pandemic shock and recovery to reduced baseline GDP
 

While we focus throughout this paper on the reduction in the level of aggregate GDP, the impact on GDP per capita will be lower due to the reduction in population during a pandemic. The effect on long run GDP per capita will depend on the pandemic’s effect on labour productivity, which as discussed above is difficult to predict.

Notes

  • [9]Using for example the procedures used in SVAR models of the New Zealand economy, summarised in Buckle, Kim, Kirkham, McLellan and Sharma (2003).
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