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Madrid 2,266 EUR -0,01 (-0,61 %)

FINANCE | 04.23.2020

The three factors that will determine how economic recovery will take place

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It will be V-shaped; or perhaps it will more resemble a U; it may even end up being an L; and some even claim that it will look more like the Nike symbol.

It is difficult to anticipate what economic recovery will look like, once the terrible pandemic of recent months has been overcome.

What seems clear is that the speed with which recovery takes place and the question of whether the damage experienced over these months will be temporary or permanent, will largely depend on a number of factors. The experts from MAPFRE Economic Research have identified, in their latest Panorama update (link here), three major factors that will determine the severity of the damage that the economic fabric is subject to over these months. Let’s take a look:

1. The nature of the virus

The truth is that, despite being the focus of all the world’s attention over the past few months, many things related to COVID-19 remain unknown.

Some of the most significant unknowns are, for example, the true rate of infection and the number truly infected, which is estimated to be up to ten times more than the reported number of cases, the true case fatality rate, whether the virus has a seasonal component, whether immunization (passive and active) is possible and crucially: the true distribution of contagion cases over time (the contagion curve).

Economic recovery will therefore depend, primarily, on the responses to these unknowns. On the most benign side of the spectrum of scenarios, it can be assumed that COVID-19 has a seasonal nature and retreats in the warmer weather. In this scenario, the virus mutates at the rate of influenza and its weakest spectrum allows for relatively rapid passive immunization (reaching 20-40 percent of the population).

In a less benign scenario, some of these assumptions behave worse than expected, especially infection and immunization, and this leads to a new outbreak of seasonal virus equal to or more violent than the original because of a diminished response capacity and insufficient immunization. This would obviously have very serious consequences for economic activity.

2. The epidemiological strategy

The two major avenues under discussion are containment and suppression. The first seeks to reduce infections to manageable levels with the goal of achieving herd immunity, for which between 20 and 80 percent of the population needs to become infected. Although the economic costs are manageable, the potential cost to the health system is unaffordable.

Suppression seeks to gain time to take advantage of the seasonality of the virus, create treatments and vaccines and avoid the collapse of the medical system. However, there are two drawbacks: historical experience shows that the virus returns seasonally and forces a shift to containment strategy, leaving the population vulnerable to future new outbreaks since it strengthens the strain against which immunity has not been achieved.

Also, the economic cost is too high as can be seen at this time (metric references) due to supply disruptions, risk aversion and the financial implications that may thus evolve.

So far, virtually all countries have adopted the suppression strategy. It is hoped that this will help to save time and in the search for treatments, vaccines and strengthening of the health system. But if the nature of the virus forces a longer confinement and its impact on activity is extended, the damage to the economy will consequently be greater.

3. The institutional reaction

This concerns not only the package of measures that the various public administrations design to deal with the economic crisis arising from the health crisis, but also the capacity of these administrations to coordinate with each other effectively, nationally and internationally.

MAPFRE Economic Research thus identifies a hypothetical scenario of the “correct” institutional response, which would contribute to alleviating the economic impact of COVID-19 on society:

  • Institutions manage relevant information and manage expectations carefully
  • The recovery of goods and factor markets is accelerated
  • Mechanisms are activated to support the health system, avoiding collapse
  • Palliative measures are implemented adequately and on time. Fiscal measures for the temporary replacement of income, sensitive but controlled public sector participation (avoiding crowding out) and guarantees that enable credit to flow in support of the resumption of activity, especially in the retail sector. Monetary measures provide frictionless liquidity to the system, and control sovereign-bond risk spreads. Asset impairment in the financial system balance sheet is stopped and there are no recurrent decreases in scale (matching of assets and liabilities). The cost of the pandemic is distributed over time without leading to extreme situations. The unemployment created is temporary and default is kept under control. A systemic situation is not reached financially.

In the absence of this institutional reaction, economic deterioration could obviously be much worse and even, as the newly published Panorama Report warns, cause the duration of the crisis in vulnerable countries to transform the real crisis into financial and sovereign crises with far-reaching implications.