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COLUMN-Coronavirus confronts decision-makers with a terrible trade-off: Kemp

By John Kemp

(John Kemp is a Reuters market analyst. The views expressed are his own)

By John Kemp

LONDON, March 18 (Reuters) - At the heart of responses to coronavirus is a terrible trade-off between maximising social distancing measures to suppress the disease and the need to maintain some sense of normal economic activity.

Extreme social distancing can reduce the number of infections and deaths by reducing the person-to-person interactions necessary for the transmission of the disease, but only an extremely high economic cost.

Business-as-usual, with limited interventions such as handwashing and self-isolation, can to keep food, essential services and the rest of the economy going, but only at the cost of a large number of infections and deaths.

First in China, and now around the rest of the world, policymakers have been confronted with the same appalling trade off, from which there are no good outcomes, only choices between lesser evils.

China’s experience with locking down the province of Hubei and implementing a prolonged holiday from normal business seems to show extreme social distancing can bring an epidemic under control.

But the experience suggests economic costs are high, with the supply chain pushed close to breakdown, and could only be maintained for a short period before pressure to restart the economy became overwhelming.

At the other extreme, Italy’s early experience suggests uncontrolled transmission overwhelmed the healthcare system leading to a surge in deaths, and forced the government to introduce a nationwide lock down to arrest the rising death toll.

As the epidemic has spread around the world and infected more people, governments have struggled to identify a strategy that is politically, medically and economically sustainable, with policy oscillating as costs increase in various dimensions.


MITIGATION OR SUPPRESSION?

In Britain, the government’s initial strategy was to mitigate transmission through the population, flattening the peak and maintaining hospitalisation and intensive care rates within system limits.

The objective was to manage the case rate until the epidemic burnt itself out naturally, when enough of the population had been exposed that herd immunity had been achieved.

Policymakers abruptly reversed course when new epidemic modelling suggested the mitigation strategy would still overwhelm the capacity of the healthcare system and lead to 250,000 or more deaths.

So, the most recent policy focuses on extreme social distancing with the objective of suppressing the epidemic rather than simply mitigating it.

The switch was prompted by epidemic modelling from Imperial College London (“Impact of non-pharmaceutical interventions to reduce COVID19 mortality and healthcare demand”, March 16).

But as the authors of the study note, “suppression, while successful to date in China and South Korea, carries with it enormous social and economic costs.”

Such costs may be feasible in the very short term for a few weeks or a month, but become much more significant if extreme social distancing measures have to be maintained for longer periods.

In the Imperial College study, the authors considered social distancing the entire population combined with case isolation and household quarantine and possibly school/university closure for five months.

But the epidemic risks flaring up again once controls are relaxed. The authors acknowledge intensive restrictions on social contacts might have to be repeatedly reintroduced for an 18-month period.

Extreme social distancing measures might need to be in place two-thirds of the time until near the end of 2021, until either herd immunity has been achieved naturally or a vaccine is available.


ECONOMY-WIDE STOPPAGE

In most major economies, including Britain, the United States, China and the European Union, government strategy has now shifted to suppression.

But the enormous economic costs are being reflected in the sharp drop in equity market valuations and other risk assets.

Suppression has brought much of the passenger aviation, tourism, public transportation, retail, restaurant, entertainment, personal services and other industries to a near complete halt.

Suppression also threatens the manufacturing and distribution systems and their ability to keep moving food and other items to consumers.

The sudden stoppage threatens sales, wages, rent and tax payments, with a cascade effect that will spread even to those parts of the economy not subject to formal shutdown.

It has no parallel since the Second World War, except perhaps for the few days in the immediate aftermath of the attacks on the World Trade Centre in September 2001.


LOSS-SHARING MECHANISMS

In response, monetary policymakers have cut interest rates to zero, injected large volumes of liquidity, and promised forbearance on debts and other liabilities.

On the fiscal side, governments have pledged large tax cuts and/or increases in public spending, including transfer payments to individuals and businesses, to counter the economic crisis.

So far, most monetary and fiscal measures have done little to restore confidence, with equity prices and other risk assets continuing to slide amid a sustained flight to safety.

But monetary and fiscal stimulus can do little to sustain or revive business activity that has been shut down for non-economic reasons.

At best, policymakers can socialise losses, spreading concentrated losses suffered by the worst affected businesses and individuals and sharing them more widely across society.

Interest rate cuts spread losses among the most heavily indebted borrowers to savers. Transfer payments spread losses from the worst affected businesses and individuals to taxpayers as a whole.

Loss-sharing is a conventional response for societies facing catastrophic costs, normally through commercial insurance in the first instance but ultimately through the fiscal and monetary systems.

But loss sharing cannot make the costs go away. Shutting down large parts of the economy for much of the next 18 months will have enormous costs which is weighing heavily on financial markets.

In that sense, the fall in equity values and oil prices is entirely rational, reflecting the current assumption business activity will be severely reduced for at least five months and perhaps as much as two years.

As the full economic costs of suppression come into focus, it is possible policymakers will refine strategy further, leading to a blended strategy between suppression and mitigation, social distancing and business as usual.

In most cases, when confronted with an uncomfortable trade-off, decision-makers ultimately choose a middle course, rather than one of the extremes.

As they weigh up health and economic costs, policymakers may ultimately move to a strategy that mixes elements of suppression and mitigation, that tries to limit transmission and deaths, while re-opening parts of the economy to minimise the financial and social fallout. (Editing by Toby Chopra)