The Economic Effects of Epidemics and How to Prevent Them

This article analyses the economic effects of epidemics on the world economy. It shows that epidemics have a major impact on the economy and that they are likely to cause global GDP to fall by one-fifth.

The rapid spread of the Covid-19 epidemic in late 2019 in China, its evolution into a global pandemic in early 2020, and the contraction of activity that accompanied them are a reminder of the vulnerability of economies to infectious diseases.

The late 20th and early 21st centuries saw the emergence and rapid spread of numerous epidemics, some of which remain active or in an expansion phase. These epidemics have had obvious economic effects, ranging from a few tenths of a point to several points of GDP depending on their severity.

The various historical examples suggest that an epidemic can be transmitted to the economy through several channels, affecting the labor force and changing the behavior of agents in response to health developments. Epidemics can also have long-term effects on productivity and initiate structural changes. In general, the main academic works agree in concluding that the economic cost of epidemics tends to increase with their health severity.

Quantifying the economic effects of epidemics is fraught with uncertainty. On the one hand, some epidemiological parameters are subject to assumptions, which leads to ex-ante uncertainty about the health consequences as well as the economic effects. On the other hand, some epidemics may have relatively long-term economic effects, which should be included in the evaluation of their aggregate cost, but whose measurement, even ex-post, is hampered by the availability of data or by difficulties in identifying the specific effects.

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Double exposure of US Coronavirus COVID-19 cases with stock market headline (March 18, 2020). Photo by Brian McGowan on Unsplash

The economic effects of the Covid-19 pandemic would be primarily the result of the sudden halt in global economic activity, reflecting both public measures in many countries and voluntary avoidance behavior by individuals. Longer-term effects are also likely to materialize, including sectoral reallocation from the heterogeneity of the shock across sectors, although it is too early to predict these precisely. 

  1.  Channels of transmission of epidemics to the economy

Epidemics are transmitted to the real economy through different channels: they can affect supply, through the labor force, hours worked, productivity, and demand, through consumption and business investment decisions. Demand effects may be reinforced by changes in agents’ behavior, or exacerbated by the economically restrictive nature of the health measures implemented. Moreover, even for epidemics of comparable magnitude, these effects may vary significantly between countries, reflecting their specific characteristics.

In the short term, in the absence of an effective vaccine or treatment, infections result in a temporary or permanent decrease in the labor force, with a likely increasing impact on aggregate productivity as the prevalence and duration of the epidemic increases. The long-term effects depend on the characteristics of the epidemics. Indeed, a highly virulent epidemic among working-age adults reduces the labor force, as did the Spanish flu pandemic of 1918-1920, which resulted in 40 million deaths (with very high mortality among 20-40 year-olds). It may also lead to sequels of the epidemic, such as the death of a child. It can also lead to long-lasting or disabling after-effects, which can affect both labor supply and productivity, as endemic diseases – such as AIDS before the discovery of treatments – reduce incentives to invest in human capital and health.

Long-term effects can also emanate from the fact that the pandemic is not just a disease, but also an opportunity to improve the quality of life. Long-term effects can also arise from diseases that disproportionately affect children (malaria, hookworms), reducing the productivity of their education and leading to developmental delays. Endemic diseases, or equivalently the recurrence of epidemics in adults as well as diseases affecting children, can thus contribute to the growth of inequalities in the broadest sense.

3. Economic effects of past epidemics

Historically, the economic impact of localized or low-transmission epidemics would be limited. Epidemics cause a short-term fiscal impact and a long-term economic impact on the nations around the world. Efforts to curb the epidemic include imposing quarantine, preparing health facilities, isolating infectious cases, and tracing contacts involving public health resources, human resources, and implementation costs. It also involves health system expenditures to provide health facilities to infectious cases and the arrangement of consumables such as antibiotics, medical supplies, and personal protective equipment.

Pandemics can also result in declined tax revenues and increased expenditure, which causes fiscal stress, especially in lower-middle-income countries (LMICs) where fiscal constraints are higher, and tax systems still need improvement. This economic impact severity was observed during the Ebola virus in Liberia due to the rise in public health expenditure, economic downfall, and revenue decline due to the government’s inability to raise revenue because of quarantine and curfews. Economic shocks are common during pandemics due to shortage of labor because of illness, rise in mortality, and fear-induced behavior. Other than labor shortages, disruption of transportation, closed down of workplaces, restricted trade and travel, and closed land borders are reasons for the pandemic’s economic slowdown.

4. The case of the Covid-19 pandemic

The deterioration of the health situation due to the spread of the Covid-19 pandemic and the sanitary measures that were taken have weighed heavily on global activity. The severity of the restraint measures and the prophylactic voluntary avoidance behaviors of individuals are the main causes of the economic shock, although it is not easy to establish their respective contributions. From a health perspective, initial estimates suggest that the earlier strict restrictions are put in place, the more effective they are in containing the epidemic, resulting in lower economic costs, in part because the earlier implementation of restrictions reduces their duration. The link between the severity of health measures and economic costs has been well established in the literature, but the relationship varies from country to country. 

Indeed, some countries experienced an economic shock of similar magnitude to others that implemented much more restrictive measures (such as Sweden and its neighbors, see below). Conversely, economic effects can vary between countries even when the degree of severity of the epidemic is similar (for example, the anticipated economic shock for 2020 is twice as large in Greece as in Russia, for a comparable health outcome, see Cover Chart). These differences may stem from country-specific characteristics, such as different sectoral exposures, differences in job adaptability, different degrees of urban concentration, or differences in household behaviors ( the already strong social distancing in some Asian countries, or the habit of wearing masks). The few available studies of the first wave of the Covid-19 pandemic corroborate the economic impact of voluntary changes in household behavior. 

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