Econ Talks: Business Impact of COVID-19

Shortly after the World Health Organization declared COVID-19 a pandemic, stock markets around the world experienced serious meltdowns, triggering the New York Stock Exchange’s shutdown mechanism multiple times in the following days. Many begin to question whether this could be the start of another global recession, and how the pandemic would affect the global economy as it continues to spread worldwide.

The World Health Organization (WHO) declared COVID-19 a pandemic on March 11, warning people of the sustained risk of further global outbreak. Following the announcement, stock markets worldwide suffered great losses. Fear of a global recession led to one of the worst market panics in decades, causing huge drops in market indexes such as the Dow Jones Industrial Average, the S&P 500, and the Nasdaq Composite Index. On the following day, US President Donald Trump announced a 30-day travel ban between Europe and the US, which not only resulted in the lack of public confidence in President Trump’s response to COVID-19, but also caused even more serious stock market meltdowns, especially for the airline industry and multinational firms, since the lack of business travels between the two economic superpowers will most certainly generate difficulties for both international corporations and airline carriers there. On Thursday, following the announcement of the travel ban, the Dow Jones Industrial Index shed more than 2,300 points in what was the largest ever single-day drop in its 135-year history, marking the end of the longest 11-year bull market (a sustained period where prices rise) for US stocks.

Under the sustained risk of a full-out COVID-19 global outbreak, people around the world are wondering whether we are entering another global economic recession, or even a prolonged depression. What is the current estimate of the scale of this outbreak? How would the pandemic affect the economy in different parts of the world? And as a part of NYU Shanghai’s Chinese community, to what extent would it slow down the economic growth in China, and how would it affect China and the rest of the world differently? To answer these questions, I will introduce some of the important statistics and estimations in McKinsey & Company’s most recent report on COVID-19’s implications for business.

What do we know about COVID-19 so far?

The virus is highly transmissible from person to person. Based on current data, the US Centers for Disease Control and Prevention estimates that the virus’s reproduction number, i.e. the number of additional cases as a result of an existing case, varies between 1.6 and 2.4, making COVID-19 significantly more transmissible than the seasonal flu. Furthermore, the virus disproportionately affects older people, especially those with underlying preconditions. Although this issue remains controversial, the overall case-fatality ratio is calculated to be around 2%. Given the relatively low ratio of serious-condition patients and the high transmissibility, researchers are still working on identifying the extent of undetected milder cases, and we don’t yet possess any knowledge about the seasonality or asymptomatic transmission characteristics of COVID-19.

How will the pandemic affect the world economy?

Let’s look at China. Recent data revealed that the daily incremental cases in China have been falling dramatically ever since the end of the Lunar New Year, and are now at an all-time low. It is expected that recovery of economic activities in China (excluding Hubei) will be largely complete by late Q1 (January to March), while the situation in Hubei remains hard to foresee until mid or late Q2. Larger companies in China are resuming daily operations, despite facing labor shortages and logistic difficulties. Meanwhile, small businesses are facing greater challenges, chief among which are labor disruptions and access to business loans. The report also points out that the recovery of consumer confidence in China will lag behind economic restart, but past experiences proved it resilient. In some sectors though, the effects of the outbreak may last well into Q2, e.g. tourism, hospitality and commercial aviation. There is hardly any doubt at this point that China’s GDP growth will be heavily affected by the pandemic, especially in Q1 and Q2. Some reference figures are as follows: consumer spending on food and drink decreased by $60 billion in January and February, while sales of passenger cars suffered from a 92% drop.

Next, the rest of the world. As the future of this pandemic remains unpredictable, researchers devised two scenarios of its development. First of which is delayed recovery. In this scenario, new cases in Europe and the Americas peak around mid-April due to effective countermeasures and improved testing capacities. Moreover, the virus is assumed to be seasonal, and researchers are expecting a second surge in cases around mid-May because of public optimism and winter in the Southern Hemisphere, which will be met by better preparedness and playbook responses. Under these assumptions, a global recession is anticipated mainly as a result of quarantines, travel restrictions, and social-distancing measures which lead to reduced business and consumer spendings until the end of Q2. But a recession is self-sustaining in nature, so the effects of the recession are likely to be carried well into Q3. Rise in unemployment rate is also expected as businesses lay off workers following the loss of revenue. Following the market panic, monetary policies will not be sufficient to stabilize the market, and it will take until Q4 for European and US economies to see a genuine recovery. It is expected that global GDP in 2020 will fall slightly at the end of year.

The second scenario, called prolonged contraction, assumes a considerably worse situation, where the non-seasonal virus continues to spread and the epidemic does not peak in the Americas and Europe until May, due to problematic public-health responses and delayed testings. Even countries without previous cases or have successfully contained the outbreak will have to adopt strict protective measures to prevent new cases or resurgence. In this hypothetical scenario, the demand side of the global economy will suffer throughout the year as consumers cut down spendings, while the number of corporate layoffs and bankruptcies increases, especially in heavily affected sectors, causing and feeding a self-reinforcing downward spiral (e.g. the bankruptcy of one supplier could lead to another firm having operational difficulties, and company layoffs would cut the funding of family expenditures). In the financial sector, a full-out banking crisis can be averted with careful supervision, but the downward spiral will occur nevertheless, and the global economic impact will be severe, with significant GDP contractions.

What are some models of epidemic progression, and how may it all end?

For starters, there is the Chinese model, where governments carry out extraordinary measures like strict lockdowns and surveillance to ensure public compliance in order to combat the spread of the disease, which proved effective in China during the past few weeks. Furthermore, there is the South Korean model, where gradual control measures are implemented through effective use of public-health tools, technological integration, and a focus on healthcare-provider safety. The case count will drop more slowly in this case, but it will reduce long-term effects on the country’s socio-economic environment.

Finally, some tips from the McKinsey researchers (especially for businesses):

  • Internalizing reality is more important than following the step-to-step manual, as facts don’t always conform to what protocol says.
  • An effective mechanism requires you to think through all the costs and consequences as well as all the benefits.
  • Do not be overly optimistic about the return of demand and economic normalization.
  • Align the assumptions among different sectors of a firm or a government institution to achieve better coordination and reduce misalignments.
  • As you plan for the near future, remember that things may get worse in the long term.

This article was written by Yihan Xu. Contact via email at yx1708@nyu.edu.
Photo Credit: TIME https://time.com/5793506/a-stock-market-crash-was-coming-coronavirus-was-just-the-spark/ 

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