The real economic fallout of COVID-19

Governments around the world are pursuing extremely expansive monetary and fiscal policies to combat the economic fallout from the COVID-19 pandemic. But such largesse is appropriate for an old-style depression, not for this public health crisis.

We currently face a trade-off between social triage and economic collapse. That is because much economic activity involves physical interactions among people, including in the retail trade, restaurants, tourism, live entertainment, and most forms of office work. With social distancing being enforced, such activity comes to a halt.

Worse, COVID-19 is the first pandemic to have struck a thoroughly integrated global economy. Most goods today are products of global supply chains, where physical interactions in one location are connected to physical interactions elsewhere. Stop the physical interactions in one place, and the economic fallout is felt in many others.

Higher government spending, lower taxes, and rock-bottom interest rates may keep people afloat in the short term, but they do not stimulate productive activity when people cannot work. Nor will supplementing the incomes of the newly unemployed necessarily shore up consumption when most shops are closed and delivery services are unable to meet the exploding demand.

The problem is not a generalized drop in aggregate demand, as was the case during the Great Depression of the 1930s. Rather, it is a dramatic fall in the production and consumption of goods and services that rely on physical interactions, combined with an equally dramatic rise in the production and consumption of goods and services that don’t involve such interactions.

Regardless of how long the pandemic lasts, the organization of economic activities needs to change fundamentally.

That is why business is currently booming for Amazon and Netflix, but slumping for hotels and restaurants. In fact, the pandemic has caused a Great Economic Mismatch: Many sectors that depend on existing production and distribution processes are shedding workers, while others are unable to hire enough.

Many governments have announced fiscal measures to mitigate the pandemic’s economic impact, such as paying much of the wages of furloughed workers (as in the United Kingdom) or sending taxpayers a stimulus check (as in the United States). Canada, Denmark, France, and others are paying large parts of company payrolls so that firms remain intact.

But such initiatives aim to preserve the income from jobs that have disappeared, rather than generating income from jobs that have yet to be filled. While policies like these are appropriate for combating an economic depression or covering a temporary shortfall in aggregate demand, they will not help to address the Great Economic Mismatch.

Indeed, it would be irresponsible for governments to formulate policy on the assumption that the current pandemic is a temporary, one-time occurrence. Policymakers should not think that it is enough to give employers and employees some money to tide them over before the prompt return of economic normality.

No one knows how long the pandemic will last. If it turns out to be lengthy, then the Great Economic Mismatch should induce governments everywhere to plan for a persistent structural change. Supporting incomes from nonexistent jobs will cease to be an option, so helping people to find new jobs must become paramount.

If the pandemic is reasonably short, then governments must ensure that they are never again caught as unprepared as they are now. That will mean strengthening the economy’s resilience to pandemic shocks, by ensuring that people have the skills to perform new jobs.

So, regardless of how long the pandemic lasts, the organization of economic activities needs to change fundamentally. But thus far, governments have not risen to this challenge.

In order to understand the underlying problem and identify the policy solution, we need to devise new categories of economic activity. In particular, we need to divide production and consumption into physically interactive (PI) and physically disjointed (PD) activities.

The pandemic is dramatically restructuring global supply chains and consumption behavior to the detriment of PI activities and in favor of PD activities. Consequently, the primary job of governments is not to make up for a shortfall in aggregate demand, but rather to finance the adjustments needed to overcome the Great Economic Mismatch.

It is not enough to provide income support to people without jobs; governments must also give them access to essential goods and services such as food and medical care, as well as to PD support for mental and physical health. Nowadays, this access is far from assured in many countries, leading to widespread anxiety and despair.

Employment services can play a vital role by identifying the rapidly proliferating PD jobs and conveying this information to people engaged in PI activities. Finance and labor ministries, meanwhile, should subsidize relocation and training expenses.

To promote the movement of workers from vanishing PI jobs into readily available PD positions, governments should provide hiring subsidies. These are far superior to payroll-tax reductions, which aim to preserve old jobs rather than overcoming the mismatch.

Furthermore, a pandemic is a public bad, and individuals do not have to pay the full cost of the damage they cause to others by transmitting the virus. Because the free-market system cannot deal efficiently with this problem, testing and treatment must be financed by the government. This is accepted as a matter of course in some countries (such as Germany and South Korea), but woefully ignored by others (such as the U.S.).

True, subsidizing the adjustment costs generated by the Great Economic Mismatch will be expensive. But the amounts involved would be small compared to the sums that many governments are currently planning to spend in response to the economic fallout of the pandemic.

The fallout is not slumping demand, but rather the abrupt and rapid shift in our production and consumption activities. Instead of desperately applying old solutions to a new problem, governments everywhere must help economies adjust to this change.