Saturday, May 16, 2020

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.

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