If you looked at nothing but a chart of the S&P 500, you would think we were entering a depression or nearing the apocalypse. But what are the real impacts of a pandemic like COVID-19? The stock market is an easy gauge to follow for sentiment, but how well can it measure real economic impact?
Using data from prior pandemics, I will quantify the estimated impact of the current COVID-19 crisis. I will also provide a cost-benefit analysis of preventing future pandemic outbreaks by comparing investments in the necessary precautions and infrastructure to the expected economic fallout and “repair costs” incurred by governments and central bank interventions.
While I’ve never lived through an epidemic of this size (not yet quite born in time for the Spanish flu of 1918), I witnessed firsthand the fundamental economic impacts throughout central and eastern Europe following the fall of the Iron Curtain. Working in an advisory role for Price Waterhouse, I’ve had to value many things most thought were unquantifiable. Helping to stabilize and develop asset-heavy businesses in the aftermath of the 2009 financial crisis put me into a similar dilemma, especially when there is no reference point or actively traded market available.
Pandemic Costs Throughout the Past Century
Pandemic risk is a combination of low probability (est. 1-3% p.a.), infrequent occurrence, and—depending on prevention and containment measures—high to severe economic impact (up to $3 trillion). While pandemics have been observed in different forms and shapes throughout mankind’s history, one common element is their constant underestimation combined with public complacency. However, the unfolding COVID-19 crisis made it painfully clear that in today’s globalized and interconnected world, the risk is much more prevalent than ever before. The latter is probably the most distinguishing factor of COVID-19 compared to other, more localized pandemics throughout the past 100 years.
As a result, almost every country around the world has been affected, among them large, developed economies like the US, Western Europe, and Japan. Compared to the SARS outbreak almost 20 years ago, this time, the impact is felt directly in these advanced economies due to significant loss of human life and full-blown economic impacts.
So why does it matter?
Let’s take a somewhat cynical view of the world and assume that the costs of human life are mostly a concern of the actuary profession and barely featured in daily political discussions. However, shedding billions of dollars of stock market valuations within days with the potential to put 30% of the workforce (and electorate) out of a job gets a lot of attention.
So, putting that economic argument into perspective, let’s see what makes a pandemic so costly and try to illustrate the argument citing major outbreaks over the past 100 years.
How Much Does a Pandemic Cost?
Let’s start with a cost breakdown using an animal disease outbreak as a proxy, which, based on what we know so far, closely mirrors the cause and effect relationship in the current COVID-19 outbreak.
The World Organisation for Animal Health published a study analyzing Avian flu outbreaks in South America, Asia, Europe, and Africa in 2007, which quantified direct costs and losses as well as indirect impacts including ripple, spillover, and wider societal impacts.
As illustrated, 70% of the overall cost impact is indirect but fully attributable to the underlying contagion. Herein lies the biggest dilemma. The diffuseness and time lag (typically 1-2 years) of occurrence make it rather difficult to identify and measure the full impact. Special circumstances like WWI (Spanish flu, 1918-20) or the sheer lack of data (Asian flu, 1957-58) are additional factors that explain past political complacency.
The following provides a summary of major past pandemics that occurred throughout the past century and the associated estimated total economic and social losses.
|Spanish flu||1918-20||Global||~500M / 50M (10%)|
|Asian flu||1957-58||Global||~500M/~2M (0.40%)|
|SARS||2002-03||Southern China||8,098 / 774 (9.60%)|
|Swine flu||2009-10||Global||~6.7M/ ~20,000 (0.3%)*|
|Ebola||2013-16||Mainly West Africa||28,646 / 11,323 (39.50%)|
|MERS||2012-17||Mainly Middle East||2,506/ 862 (34%)|
*Subsequent outbreak in India (2015) with an almost 6% mortality rate
Source: World Bank estimates, Toptal calculations.
Outsized Impacts on Low-income Countries
There have been various attempts in the past to quantify economic losses caused by pandemics using historical data. The World Bank, for instance, estimates severe pandemics like the Spanish flu are likely to reduce GDP by 5%, caused primarily (60%) by disruptive effects of preventive measures (shutting down economic and public life). Other studies even talk about GNI (Gross National Income) losses of up to 12% worldwide, with the most severe impacts attributable to low-income countries losing 50% of their respective GNI.
However, our review of academic literature finds a scenario outlined in a paper published by three US university professors, including Larry Summers at Harvard’s Kennedy School, most reasonable. While prior studies focused on income losses only, caused by reductions in labor force and productivity losses due to absence and disruption, the model employed by the Fan/Jamison/Summers study took a more comprehensive view. It expanded the component income losses by a component designed to capture the cost of excess mortality, commonly referred to as a statistical life. This value is derived from questionnaires capturing the excess income an individual would demand for a corresponding increase in mortality risk.
Another source is quantitative labor market studies. Statistical life value calculations commonly are prepared in conjunction with estimating costs of vaccine-preventable diseases or the burden of environmental risk factors (i.e., does it pay off to reduce carbon dioxide emissions to reduce respiratory diseases by subsidizing electric cars?). Given this rather comprehensive approach to calculate economic losses, we believe the Fan/Jamison/Summers study is superior to previous attempts to quantify the economic costs of a pandemic.
Using an “expected loss” framework accounting for the risk of an uncertain event, expanded with information about the severity or value of that event, the authors arrived at the following impact matrix outlining mortality and economic losses of influenza pandemic risk, like in the case of COVID-19:
The country income group classification is derived from annually adjusted GNI per capita thresholds published by the World Bank Group. The latest available data as of June 2019 shows the following thresholds:
|Income Group||GNI per capita threshold (US $)|
|Low (L)||< $1,026|
|Lower middle (LM)||$1,026 - 3,995|
|Upper middle (UM)||$3,996 - 12,375|
While both mortality rates and expected economic losses are still significant according to the impact matrix above, it is promising that, over the last 30 years, most countries are steadily moving up the ladder of prosperity. Consequently, the most vulnerable populations have become a smaller piece of the pie.
This fact, in particular, is a silver lining in the current discussion about the expected fallout from COVID-19.
Estimated Economic Losses from COVID-19 Thus Far
As this report is written, the economic fallout from COVID-19 is just emerging. Given the pandemic’s unprecedented speed, global reach, and impact in a globalized and highly interconnected world, quantifying its full economic impact will take at least a year or two, if not longer.
Given the notable shortcomings in the countries’ ability to handle and contain the outbreak but also the built-in economic mouse traps, like China-only supply chains, additional “resurrection” costs will need to be incurred but are impossible to quantify from today’s perspective. Another big question to be answered by history but crucial when determining the COVID-19 losses will be the pandemic’s duration and severity, especially in Europe and the United States, two regions where the peak of the crisis is still a few weeks out.
Given the caveats above, let’s do a quick “back of the envelope” calculation for the most affected countries to date (April 7, 2020) to see where we might be heading.
|Country||WB Income Classification||Economic Loss Ratio*||Estimated Annual Economic Losses [USD]|
|China||Upper middle||1.0%||$135.6 billion|
|United States||High||0.3%||$62.5 billion|
|United Kingdom||High||0.3%||$8.5 billion|
|Iran||Upper middle||1.0%||$4.6 billion|
*The Economic Loss Ratio as a percentage value of Gross National Income (GNI) represents the total expected annual economic losses, consisting of income losses and excess mortality.
Source: World Bank, Pandemic risk: how large are the expected losses?, and Toptal calculations.
In total, these major economies affected by COVID-19 are expected to incur estimated annual economic losses of US $242.5 billion, which is more than four times the largest economic fallout from an epidemic recorded to date. The most costly epidemic previously was Ebola with an estimated total cost of $53 billion.
How does this compare to what the equity markets are currently baking in? The S&P 500 stood at 3,231 as of December 31st, 2019 and was worth US $26.7 trillion. Since then, it has shed 594 points or 18.4% of its value. Translating this into US dollars, US $4.9 trillion has been wiped out of US stock markets alone.
How can we explain the disconnect between calculated annual economic losses and the stock market’s reaction? Well, the honest answer is, we can’t, but let’s give it a try nevertheless.
Equity markets tend to overreact. This is especially true in today’s highly indexed and automated trading world. Leaving aside this element of exaggeration, we need to keep in mind that the calculated loss estimation of US $242.5 billion is an annual amount. Given today’s expectation of a total duration for the COVID-19 pandemic of at least one to two years, these amounts could increase dramatically, assuming similar impacts throughout all cycles. The third and most likely most undervalued impact stems from the fact that negative economic impacts due to globalized supply chains and markets are not factored into the underlying model used for these calculations.
Extending on the likely impact of globalized supply chains, another interesting observation is the distinct performance of various global market indices. Whereas the Shanghai Composite Index lost only a little under 9% this year, the S&P 500 and the Euro Stoxx 50 are down roughly 17% and 25%, respectively. This is a likely indicator for impact differentiation due to different levels of economic connectivity and therefore the severity of supply chain disruptions.
So, is this an appropriate market response? We don’t know yet. To a large extent, it depends on how long the crisis lasts, how well the medical system will be able to cope (“flattening the curve”), and how speedily the interconnected global economy will pick up again. However, the following comparison of the S&P’s reaction in the current crisis compared to past ones raises doubts about the appropriateness of the current stock market fallout. Moreover, it reflects both a distinct lack of information and fear.
So where do we go from here?
The Way Forward
Even with the full impact of COVID-19 just emerging, it is clear that more must be done to significantly increase global preparedness and risk awareness for the inevitable outbreak of future influenza and other pandemics. Risks are rising not least due to the level of globalization and interconnectedness but also the accelerated pace of urbanization increasing the speed of contaminations and thus reducing lead times for authorities to enact and coordinate countermeasures.
The Global Preparedness Monitoring Board recommends the following key measures in its September 2019 report:
- Heads of government must commit and invest.
- Countries and regional organizations must lead by example.
- All countries must build strong systems.
- Countries, donors, and multilateral institutions must be prepared for the worst.
- Financing institutions must link preparedness with financial risk planning.
- Development assistance funders must create incentives and increase funding for preparedness.
- The United Nations must strengthen coordination mechanisms.
Given the high stakes at play, pandemic prevention and containment must become part of the competitive advantage toolbox deployed by economic policymakers as well as management of individual companies and organizations.
The Bottom Line
Economic losses caused by pandemics are on par with other high-profile economic threats like climate change (0.2-2.0% of global GDP at risk) or large-scale natural disasters (0.3-0.5% of global GDP at risk). All three are qualified as major economic disasters by the IMF with 0.5% or more of global GDP at risk.
However, while natural disasters and, in particular, climate change are declared frontline issues attracting both political attention and significant funding, pandemic risk is not.
The US National Academy of Medicine estimates that committing an incremental US $4.5 billion annually to be used primarily for strengthening national public health systems, funding R&D, and financing global coordination and contingency efforts would significantly reduce the severity of future outbreaks.
Compared to economic losses of up to US $50 billion incurred as a result of past pandemics and estimated losses from the current COVID-19 threat, US $4.5 billion goes a long way.
The World Bank and WHO estimate that as little as US $1-2 per capita per year spent on pandemic preparedness would allow for adequate preparedness. Investing in preparedness also yields significant financial benefits. As an example, an annual investment between US $1.9-3.4 billion to strengthen animal and human health systems would yield an estimated global public benefit of more than US $30 billion. Not a bad rate of return.
Understanding the basics
A pandemic is a global outbreak of disease. It is an epidemic that has spread across multiple continents, or worldwide.