Natural Disasters (and Pandemics), Man Made Disasters (and Lockdowns) and Economic Growth

As the COVID-19 pandemic spread to Europe in early 2020, most countries decided to establish a lockdown, with one notable exception - Sweden. This was followed with a large public debate, usually on social media, on the benefits and costs of the lockdown. This discussion focuses on two points: (1) the human cost - is the lockdown efficient in reducing the loss of lives?; (2) the economic cost - Are the lockdowns condemning a generation to poverty? are we exchanging a natural disaster (a pandemic) for a man made disaster (lockdowns)?

While I defer the discussion regarding the first point to epidemiologists and other public health experts, my research on the impacts of the 2004 Indian Ocean Tsunami has lead me to examine the literature on the impact of natural disasters (including pandemics), and man made disasters on economic growth.

The short answer is: No - lockdowns are not condemning a generation to poverty. Lockdowns are likely to have larger short term economic costs than the actual pandemic, yet, regardless of the path taken, economies will recover to their previous growth path, with no long term impact on poverty or literacy.

Before I start I should distinguish between two different time horizons: (a) short term, and (b) long term. Take the year-over-year growth rate of real GDP for the US in the graph below. The blue line is the quarterly GDP numbers released by the Bureau of Economic Analysis that varies depending on the season (economic activity is higher during the summer than during winter), depending on the economic cycle (booming years like the 1960's saw a higher economic activity than recession years like the 2009 Great Recession) and the trend - the red line. We can think of long term economic growth as the trend, which is what determines GDP in 20 years or more, and short term GDP as all the other factors (seasonality and cyclicality) of GDP, what makes the official GDP numbers vary around the trend.

Economic literature is clear on the impact of natural and man made disasters on long term economic growth - there is no negative impact only some potential positive impacts. For instance, David and Weinstein (2002) found that the atomic bombings of Hiroshima and Nagasaki had only temporary impact on the development of those cities. Miguel and Roland (2011) found that the US bombing of Vietnam had no long term impact on poverty rates, literacy rates or consumption. Skidmore and Toya (2002) show that repeated climate disasters have a positive impact on long-term economic growth, through greater innovation, though the impact is lower of geological disasters. More specifically, in a recent review of the literature Garret (2008) states that the 1918 Spanish Influenza had mostly short term impacts.

Are we exchanging a natural disaster for a man made disaster on long term growth? There is no reason to believe that either the lockdown or the pandemic will have long lasting impacts in long term economic growth. 10 years from now Sweden will not be further head of its European counterparts that decided to lockdown. This is in line most economic research on growth that build on the Ramsey/Solow-Sawn growth model that attributes long-term economic growth to technological progress.

The short term impact of pandemics and lockdowns on economic growth are harder to measure. Eichenbaum, Rebelo and Trabandt (2020) develop a model that incorporates epidemiology into the standard economic model. The authors argue that pandemics lead to slower economic growth as people reduce consumption and work to avoid getting infected. They further argue that there is a case for government intervention as individuals do not bear the entire cost of their actions (infecting other people). However, lockdowns make recessions worse thought they save lives. These findings are based on economic models since there is little empirical evidence, since the 1918 pandemic pre-dates the systematic collection of economic data.

What is worse for economic growth - the pandemic or the lockdown? The pandemic is likely to lead to a recession - a lockdown is likely to make it worse (by an unknown amount) while saving lives - however, whatever the path taken, in 10 years from now economies will recover and neither choice will likely lead to a larger benefit in terms of economic growth, poverty and literacy rates.

The views expressed in this post are my own and do not represent the views of my current or past employers.

The U.S. Federal Debt - How big is too big?

The Federal debt has risen on average +8.5% each year over the last 52 years, from $320bn in the beginning of 1966 to $22tn at the end of 2018.

At the same time, national income, as measured by nominal Gross Domestic Product (GDP) has increased on average only +6.4% per year. As the Federal debt increased at a faster pace than GDP the debt to GDP ratio has increased from 40.3% in 1966 to 105.3% in 2018.

Policy makers and economists alike have become concerned regarding the debt level. Is the current debt level sustainable?

Historically low interest rates make the direct cost of the U.S. Federal debt, the interest payments on the debt, far from their historical maximums. Interest payments depend not only on the size of debt but also on interest rates. Since the 1980’s interest rates on the 10-year Treasury bonds have declined from a maximum of 15.15% in 1981 to 2.53% in 2019.

As a result, interest payments on the current Federal debt has declined from a maximum of 5.0% in 1995 to 3.2% in 2019.

We must not forget the indirect costs of the U.S. Federal debt. There are several channels through which high U.S. Federal debt could adversely impact medium- and long-run growth which have received attention in the economics literature. High public debt can adversely affect capital accumulation and growth via higher long-term interest rates, higher future taxation, inflation, and greater uncertainty regarding economic policies and prospects. In more extreme cases of a debt crisis, by triggering a banking or currency crisis, these effects can be magnified. High debt is also likely to constrain the scope for stabilization policies during recessions, which may result in higher volatility in terms of GDP growth, inflation and employment and further lower growth.

Today U.S. real GDP growth is on average 1.3 percentage points lower, relative to 1966 due to the increase in the debt-to-GDP ratio. In general, the estimated impact of the U.S. Federal debt on growth is small, with a 10 percentage points increase in the initial debt-to-GDP ratio leading to 20 basis points slowdown in annual real per capita GDP growth . This implies that the U.S. economy could have grown at 4.2% in 2018 instead of the 2.9% recorded at the end of the year, if the debt-to-GDP level had remained at its 1966 level.

A large number of empirical papers find that the relationship between debt and growth is non-linear and characterized by the presence of a threshold, around 90 to 100 of debt-to-GDP, above which debt starts having a larger negative effect on economic growth. However, the negative relationship between debt and growth and the classic 90 percent threshold are not robust across samples, specifications, and estimation techniques. In particular, there is evidence that the effect of debt depends on the quality of institutions and that its negative effect is confined to non-democratic developing countries and economies in which the majority of debt-holders are non-resident. It is not clear whether a debt overhang argument can be easily applied to the U.S. economy.

In conclusion, the cost of the Federal debt in terms of real GDP growth could already be large and the U.S. economy could benefit from a reduction in Federal debt. However, it is unlikely that U.S. economic growth will collapse if it passed a certain critical level of debt-to-GDP.

Wage Subsidies and the Labor Supply of Older People: Evidence from Singapore's Workfare Income Supplement Scheme

I currently completed and submitted to a journal a paper on the labour supply impact of a wage subsidy program for older workers. In particular, I looked at the impact of the Workfare Income Supplement Scheme in Singapore and found that the program increased the labour supply of women age 60 to 64 by 3.3 and 5.4 percentage points. This is the same paper I presented at the Asian Pacific Economies Seminar in May. You can find the paper on SSRN.

Using Wikipedia to enhance student learning: A case study in economics

I have completed and uploaded on SSRN a new version of my joint paper with JingPing Li on using Wikipedia in teaching economics.

Rural-Urban Migration and the Skill Wage Premium in Brazil: 1980-2000

I have uploaded a new version of my paper on rural-urban migration and the skill wage premium in Brazil. It is available on SSRN

Cidade De Deus Redux: Inequality, Migration and Violent Crime in Brazil between 1980 and 2000

I recently finished a first draft of my paper "Cidade de Deus Redux: Inequality, Migration and Violent Crime in Brazil between 1980 and 2000". It is available on SSRN (just follow the link). Feel free to send any comment or question you may have.

Using Wikipedia to enhance student learning in Economics

I have finished a first draft of my joint work with Li JingPing on "Using Wikipedia to enhance student learning in Economics". I had the opportunity to present this paper at the Development in Economics Education conference in Exeter, UK, organized by the Higher Education Academy in the UK.

This presentation also lead to a follow up in The Economics Network newsletter where I talked about our conference and my research on economics education.

European Economic Association Conference, European Regional Science Association Conference, European Association of Labour Economists and Portuguese Economic Journal Meetings

During this summer I had the opportunity to present my joint work with Xiaoye Li - "How immigration reduced social capital in the U.S.:2005-2011" at the European Economic Association Conference in Gothenburg, Sweden; the European Regional Science Association Conference in Palermo, Italy; the European Association of Labour Economics Conference in Turin, Italy and the Portuguese Economic Journal Meeting in Covilhã, Portugal.

Thank you to all the participants in these meetings for their comments. We are currently revising the article and be uploading and submitting a new version of this paper soon.

How Immigration Reduced Social Capital in the US: 2005-2011

http://ssrn.com/abstract=2222650
Joint work with Xiaoye Li submitted to Journal. Furthermore, will be presenting this paper at a seminar at the University of Nottingham - Ningbo and Western Economic Association International  (WEAI) Meeting in Tokyo this March.

How the 1978 Changes to the Foreign Domestic Workers Law in Singapore Increased the Female Labour Supply

http://dx.doi.org/10.2139/ssrn.2220107
Finally submitted to Journal.