Being an economist isn’t easy these days. Since COVID-19 hit, financial markets have been battered, and the outlook for the economy remains uncertain, to say the least.
Nonetheless, it’s our job to give some perspective to the crisis.
To do that, we need to layout some general assumptions. Most importantly, we believe the current panic, as is the case with almost all panics, is overblown. COVID-19 is a strain of flu that spreads rapidly. It’s much less deadly, for example, than SARS, but it will infect many more people.
Since the symptoms of COVID-19 resemble the flu, the actual number of people infected is impossible to gauge. We believe, though, that the final number who actually contract it will be far less than the 50 million in the U.S. who catch the ordinary flu and the 50,000 who will die from it in a typical year. These statistics suggest that there’s more risk from dying from an ordinary flu than from COVID-19.
While we are skeptical of the news reports coming out of China, there’s enough convincing evidence to suggest that COVID-19 has already peaked there. That means the geometric rate of spread of the disease in the U.S. (doubling every 5 days), as scary as it is, most likely will soon slow.
We’re not epidemiologists, of course, but we’re economists who know about statistics and probability. Over the last 20 years, we’ve been hit with SARS and H1N1-A viruses. Turns out that the bark of these coronaviruses was worse than the bite.
Typically, during a period of heightened uncertainty, there’s a general tendency to initially exaggerate the negative effects of whatever caused the fear in the first place. This is even more true these days as cable news and online reports almost instantaneously spread the news, much of which is undocumented.
Not only does alarmist news sell, but it’s also politically and legally safer to overplay rather than underplay a potential problem. If one predicts that COVID-19 will be far worse than it actually turns out to be, that failed prediction will be either forgotten or applauded for encouraging people to take protective measures. But woe unto that person who discounts the bogeyman and, as a result, is accused of leading people to be underprepared.
As economists, though, we realize that there is a good reason to fear the economic effects of fear.
Even if COVID-19 doesn’t turn out to be as disastrous as some claim, we know that the fear of it is causing people to hunker down close to home. This means lower spending.
In an increasingly interconnected global economy, it also means that disruptions to supply chains will have more adverse effects than similar crisis had in the past.
To get a rough measure of COVID-19’s “fear impact,” we selected service sectors that we believe will be most negatively affected, losing 20% of their contribution to real GDP (see Chart 1) and those less affected, losing 10% (see Chart 2).
In manufacturing, we’re assuming that supply chain disruptions will lead to a 5% drop in the contribution to real GDP as generated by the entire manufacturing sector.
Finally, we’ve assumed that these losses to real GDP will occur over a six-month period.
Given these assumptions, our model points to a projected decline of roughly $175 billion in real GDP from the service sectors most affected (Chart 1) and a loss of $40 billion from those service sectors less affected (Chart 2). The projected 5% decline in manufacturing will lead to an additional loss of $55 billion.
These projected losses total $270 billion. Assuming a multiplier of 2 as the direct losses filter through the rest of the economy, the aggregate drop in real GDP is projected to be $540 billion.
This decline, however, will be offset by growth in other sectors of the economy, especially in the first and fourth quarters of this year, which we are assuming will not be affected by COVID-19. As a result, instead of real GDP increasing at a 1.9% as we forecasted in December, we see essentially zero growth in 2020.
Chart 3 shows a comparison of our December quarterly forecasts with our revised forecasts. Notice that our revised forecast calls for a -2.8% decline in real GDP in the second quarter of this year and a decline of -3.7% in the third.
Will it be that bad? We doubt it, but given our assumptions, we’ve at least placed an order of magnitude on COVID-19’s “fear impact.” The magnitude of that projected loss is significant, but not much more than a moderate recession. It’s not, however, the economic disaster that many fear. More importantly, it will end quickly.
Editor’s Note: Chapman’s Doti and Sfeir biannually issue economic forecasts, which are among the nation’s most accurate predictors of gross domestic product (GDP).
