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  • Mathieu Provencher

How did the economy catch COVID-19?

(Picture from Wix's library)

Hello everyone. I hope that you and your loved ones are all safe and well protected. Before we start, let me share a piece of information regarding the virus that is currently shaking the world. This was directly taken from the World Health Organisation (WHO) website:

“Coronavirus disease (COVID-19) is a new strain that was discovered in 2019 and has not been previously identified in humans. Common signs of infection include respiratory symptoms, fever, cough, shortness of breath and breathing difficulties. In more severe cases, infection can cause pneumonia, severe acute respiratory syndrome, kidney failure and even death. Standard recommendations to prevent infection spread include regular hand washing, covering mouth and nose when coughing and sneezing, thoroughly cooking meat and eggs. Avoid close contact with anyone showing symptoms of respiratory illness such as coughing and sneezing.”

SO! Let’s discuss why economies of many countries are suffering from the emergence of this new infection.

For the purpose of this discussion, we can separate the economy in two broad activities: the real economy (composed of goods and services) and the speculative economy (composed of financial stocks, currencies, some commodities, and more).

Economists usually measure the economy using the first type of activities: goods and services. When we talk about a recession or a depression, we refer to a reduction in production of goods (physical products) and services (immaterial products) of a country (including exports).

For the real economy, the current pandemic (of COVID-19) has two main effects: (1) mortality and morbidity; and (2) preventative (or imaginary). These effects are not exclusive to the current issues and can be seen in almost any large-scale shock.

Mortality and morbidity can reduce economic activities in very obvious ways. First of all, mortality means that people die… and dead people can’t produce anything. This loss of life, and thus working hours, can lead to lower production overall in the country if enough people are deceased.

Morbidity measures the loss of productivity due to physical or emotional pain. Morbidity can come from the mortality of someone close or can also come from sickness (physical and mental). Having flu symptoms can lead to a loss of working hours or to lower productivity while working. Relevant to the current situation, panic or fear can also lead to people missing work or being less productive while at work.

From what I could read and hear from credible media outlets, it seems that the mortality and morbidity effects of COVID-19 have not been very strong so far. There have been deaths around the world and people have suffered symptoms from illness but the effect of those on total production of any given country seem to be very subtle, if detectable at all.

The biggest shock to the real economy comes from the preventative effects of the current pandemic. This type of shocks includes internal and external restrictions on the movement of people and products (reduction in international trade, ban and cancellation of visas, closure of trade and tourist routes such as airports, bus, trains, and ships… and more), closure of economic activities (such as non-essential products), ban or quotas on remaining economic activities (amount of people going out, grocery stores stocks, etc.), closure of government offices and services, and the like.

As you may imagine, more economic activities being closed lead to less production in the country (some of those activities may be partially replaced by informal activities, depending on the culture of the country). These preventative measures are and indirect shock of the pandemic but can have a much stronger effect on the economy.

In the current situation, many countries started feeling these preventative measures even before the virus was recorded outside of China. Once the problem was recognised and publicised in China, the government took extreme measures to slow its spread. One of these measures was the isolation of the region from which it had emerged. As economic activities were shut down in China, most of the rest of the world started feeling its effects.

Production lines are very complex these days. Most products we use and buy have moved around many countries before getting into your hands. One important part of the supply chain is China, which still provides important steps when making things. As China closed some of its provinces and industries to slow the progress of COVID-19, it also closed its associated factories and manufacturing centers. As such, many inputs of production (used to make other products) and final products (what we actually buy) were not produced anymore.

In the past (let’s say around 20 years ago), this might not have had such an impact on the rest of the world. In those days (yes I’m old enough to remember those), most industries kept a substantial amount of stocks of inputs and final products. If the supply chain got slowed down or even stopped, these firms could simply use these stocks (kept in their warehouses) and continue producing and selling for a while, up until the problem went away.

These days, many industries switched to what we call “just in time” production. Those firms don’t keep significant stocks of inventories and buy exactly what they need … just in time to sell it.

SO… if China stops providing inputs and final products, and most firms in an industry don’t have inventories… then they can’t produce and can’t sell. This, at the beginning of the current crisis, lead to a reduction of economic activity in countries that were not directly affected by the virus.

Now that COVID-19 seems to be almost everywhere, the preventive measures I mentioned above affect directly those economies in which they are present.

For the speculative economy, changes can be completely uncorrelated to changes in the real economy. In this case, however, changes in the real economy added to fears about future economic activity brought important changes to the price of financial stocks, currencies, commodities, and others.

The speculative economy moves because of expectations about the future (sometimes very short-run, sometimes very long-run, depending on the financial market). As long as current economic shocks can be expected to have an effect in the future, it will have an effect on those markets. Note that changes in prices of financial stocks, currencies, and others tend to be much stronger than what seems justified. Speculators, as a group, tend to overreact to almost everything.

Unfortunately, changes in the speculative market can also have a strong impact on the real economy. Substantial decreases in the financial stock markets can lead to loss of profits for important investors, which may then decide to reduce or cancel their investments (building new factories, buying a house, etc.). Changes in currencies due to speculation can also affect trade between countries, which in turn affect producers of those economies. Finally, changes in the price of commodities (such as gold and silver for example) can lead to an increase or a decrease in purchases of those assets. Some countries may very well see a substantial decrease in their production following lower demand.

Well… you guys hopefully know more about the effect COVID-19, or any other international shock for that matter, can have on the economy.

Stay safe and good luck with your social isolation… which feels like any other day for me (except it’s less noisy outside)!

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