Understanding the Economic Shock of Coronavirus

COVID-19 has thrust the world into uncharted territory — managing public health measures, like social distancing, has kicked off a global recession. And the viciousness of the health and economic cycles did not even seem plausible to most experts at the beginning of March.

According to BCG Henderson Institute experts in an article for Harvard Business Review, the bigger question in a recession is not the flip to negative growth, but the shape of the shock — aka “shock geometry” — and its structural legacy. In understanding shock geometry, we can better understand COVID-19’s economic impact.

Historic shapes of the shock, in relation to the 2008 global financial crisis, can be illustrated across three different shapes. For the sake of illustration, HBR compared a V-shape (Canada), U-shape (U.S.), and L-shape (Greece). In the V-shape model, the output is displaced but growth eventually rebounds to its path. In the U-shape model, growth dropped precipitously and never bounced back to its pre-crisis trajectory; also worth noting is the gap between old and new paths remained large, illustrating one-off damage to the economy’s supply side. In the L-shape model, Greece never recovered its prior output path and the growth rate also declined.

In the case of COVID-19, both a deep V-shape and a U-shape are considered plausible. The largest challenge is preventing a U trajectory, which will be determined by the virus’s capacity to damage the economies’ supply side (i.e., capital formation).

The shock’s intensity will be determined by:

— Underlying virus properties

— Policy responses

— Consumer and corporate behavior in the face of adversity

The pandemic is particularly threatening as it extends to liquidity and capital problems on an unprecedented scale. A prolonged crisis may drive up real economy bankruptcies, making the situation even more difficult for financial systems, while the real economy of credit is starved. As HBR emphasizes, there is no “off-the-shelf cure for liquidity problems of entire real economies.”

Like 2008, countries will experience different realities with the crisis. This is due in large part to structural resilience of economies (aka “destiny”) and the capacity of medical researchers and policymakers to respond in new ways to an unprecedented challenge (aka “innovation”). The new interventions (like a vaccine or using existing treatments) and speed of innovation will determine whether it is possible to remediate lost lives and economic misery. Policy innovation could include solutions, such as a “real economy discount window” that delivers unlimited liquidity to sound households and firms, or “bridge loans” that offer zero-interest loans to households or firms for the duration of the crisis and come with a generous repayment period. Other options that introduce collaborative solutions are necessary.

This is the time for herculean efforts in policy and medical innovation. Innovation is the ultimate answer to bending the shock’s intensity and steering along a less-damaging V-shaped course.

Link to Article Referenced: https://hbr.org/2020/03/understanding-the-economic-shock-of-coronavirus