The Situation Following a Pandemic: Complexity Economics Series Part 1

Published on INFORMS Analytics Magazine (Joseph Byrum)

Author’s note: This series Seeing Economic Collapse and Recovery Through the Lens of Complexity Economics will look at the pandemic-related economic problems we currently face and how we might apply important concepts of complexity economics to better understand how to move forward. 

Chinese health authorities alerted the World Health Organization to an unusual outbreak of pneumonia in the city of Wuhan, China, on New Year’s Eve 2019 [1]. The disease COVID-19 (caused by the coronavirus) has claimed more than 410,000 lives worldwide [2] as of this writing. While other pandemics, such as the Spanish flu of 1918, have taken a higher toll in human life [3], none has damaged the economy more.

Most countries have suffered severe economic damage due to the pandemic, pushing the average rate of increase in gross domestic product (GDP) near zero around the globe [4], driven in part by steep declines in aviation, hospitality, retail and tourism, as well as the many small businesses dependent on them, exacerbated by declines in global stock. The pandemic will cost the world economy an estimated $4.1 trillion, or nearly 5% of all economic activity, according to the Asian Development Bank [5]. 

The disease is truly global in scope. In China, the world’s most populous country at 1.4 billion [6], some 200 million lost jobs [7]. China’s stock market lost $393 billion by early February [8]. The United States has also suffered; in Q1 2020 alone, the U.S. unemployment rate went from an historic low of 3.5% [9] to five times that level [10] according to Goldman Sachs. In March, the St. Louis Fed predicted a near-term U.S. unemployment rate of 32.1%  – higher than even the Great Depression of the 1930s [11].

“We are moving with alarming speed from 50-year lows in unemployment to what will likely be very high, although temporary, levels,” U.S. Federal Reserve Chairman Jerome Powell said in April [12]. Meanwhile, stock market volatility in the first quarter of 2020 was higher than in any other period measured since 1900, according to scholars at the University of Chicago. Most jumps were down, with the Dow Jones Industrial Average losing 26% of its value in that same brief period [13], as well as for the entire quarter, when it experienced the greatest losses in its history [14]. As for Europe, from mid-February to mid-March, European stocks fell by some 30%, their steepest decline since the financial crisis that began in 2008 [15]. A growth rate of -1% was predicted for the year [16].

But the handful of measures just highlighted are only some of a theoretically countless number of indicators, all of which are interconnected. Bloomberg maintains a real-time dashboard of updates to the “12 economic indicators to watch,” including some that are almost never reported, such as Chile Copper exports [17]. The Council of Economic Advisers issues a monthly report tracking 47 economic indicators for the benefit of Congress and the president.

The challenge, of course, is that humans are involved, and humans are largely unpredictable. As science writer George Zarkadakis has observed, summarizing complexity economics, “The economy is more a messy, fractal living thing than a machine” [18]. (“Fractal” describes a type of geometry occurring that features repeating or self-similar mathematical patterns found in nature.)

Human beings and their decisions are part of the natural as well as economic realm. After reading Zarkadakis’ article, Alan White commented, “The future of celestial objects can be predicted with astonishing accuracy because humans have no measurable influence on their orbits. Orbits are determined by physical interactions between celestial objects and initial conditions and algorithms do just fine. Bring unpredictable humans into the mix and everything falls apart” [19]. Behavioral economics, a branch of economics compatible with complexity economics, tries to make sense of how and why this happens. 

What Shape Will the Recovery Take?

At some point this harsh financial devastation will bottom out and there will be a recovery. For example, after falling for a period, countries’ GDP levels will rise – whether in the form of an L, U, J, W or VJ (plotting GDP fall and rise against time) [20]. But GDP – composed of consumption expenditures, gross fixed capital formation, and net exports of goods and services – is only one indicator. At the same time, there may be improvements or declines in other important economic indicators, such as unemployment, inflation, consumer spending, new job creation, new housing starts, stock market values and so on.

For the moment, we are in uncharted territory. Visualizing different scenarios for recovery can help. See, for example, the three scenarios proposed by Deloitte (mild, harsh, severe) for COVID-19 recovery [21]. The difficulty lies in knowing which one we face. 

Previous Financial Meltdown and Recovery

In the wake of the housing market turmoil of 2008, investment bank Lehman Brothers filed for bankruptcy, sending markets into a panic. Two days later, investors withdrew a record $144.5 billion from their money market accounts – 20 times the usual amount [22] – causing a near collapse of the financial system, which depends on liquidity, i.e., cash. Equity markets began a downward spiral, losing nearly half their value in 2009.

The recovery from this economic shock took several years to manifest for many reasons, including the following three causes noted by the global consulting firm Euromonitor [23]. First, the cost of bailouts and the decline in tax revenues due to lower economic activity weakened government finances. Second, the crisis led to declines in company investment (for example, R&D expenditures), leading to relatively low productivity [24]. Many of those who lost jobs in 2008 took more than six months to find a new job, becoming “long-term unemployed.” The rate of re-employment for this group was low due to atrophy of job skills and the stigma attached to being jobless.

Will our recovery from COVID-19 be as slow – or even slower? Or will it be rapid? To find out, we can look at recovery patterns through two lenses. This series of blogs will compare the equilibrium and nonequilibrium or “complexity” views of financial recovery and present a guide to seeing our current chances of recovery through the angle of complexity – drawing especially from scientists affiliated with the Santa Fe Institute [25].

References

1. Davis S. Hui, et al., 2020, “The latest 2019 novel coronavirus outbreak in Wuhan, China,” International Journal of Infectious Diseases, Jan. 14, https://www.ijidonline.com/article/S1201-9712(20)30011-4/fulltext.
2. COVID-19 Coronavirus Pandemic, https://www.worldometers.info/coronavirus/.
3. See Scott R. Baker, et al., 2020, “The Unprecedented Stock Market Reaction to COVID-19,” https://bfi.uchicago.edu/wp-content/uploads/BFI_White-Paper_Davis_3.2020.pdf. For a discussion of the 2% figure, and a warning against citing unsupported data, see “COVID-19 is not the Spanish Flu,” Wired, March 13, 2020, https://www.wired.com/story/covid-19-is-nothing-like-the-spanish-flu/.
4. Paul F. Gruneveld, 2020, S&P Global Ratings, “Economic Research: The Escalating Coronavirus Shock Is Pushing 2020 Global Growth Toward Zero,” https://www.spglobal.com/ratings/en/research/articles/200330-economic-research-the-escalating-coronavirus-shock-is-pushing-2020-global-growth-toward-zero-11413969.
5. Cited in “Virus Deaths, Unemployment Accelerating Across Europe, US,” April 5, 2020, https://www.thenationalherald.com/295933/virus-deaths-unemployment-accelerating-across-europe-us/.
6. https://www.census.gov/popclock/print.php?component=counter
7. https://www.thenationalherald.com/295933/virus-deaths-unemployment-accelerating-across-europe-us/
8. https://www.reuters.com/article/uk-factcheck-coronavirus-only-hit-wuhan/false-claim-in-china-the-coronavirus-only-hit-wuhan-chinese-stock-market-unaffected-idUSKBN21J6MT
9. “Labor Force Statistics from the Current Population Survey,” https://data.bls.gov/timeseries/LNS14000000.
10. https://www.cnbc.com/2020/03/31/coronavirus-update-goldman-sees-15percent-jobless-rate-followed-by-record-rebound.html
11. St. Louis Federal Reserve Bank prediction of March 27, 2020, https://www.stlouisfed.org/on-the-economy/2020/march/back-envelope-estimates-next-quarters-unemployment-rate.
12. Heather Long, “Fed Chair Powell says U.S. economy deteriorating with alarming speed,” The Washington Post, https://www.msn.com/en-us/money/markets/fed-chair-powell-says-us-economy-deteriorating-with-alarming-speed/ar-BB12o0Ak?ocid=spartandhp.
13. DJIA went from 27,968.80 to 20,704.91 from 2/24/2020 to 3/24/2020, https://www.barrons.com/quote/index/us/dow%20jones%20global/djia.
14. “Dow closes out worst quarter in its history,” CNN, March 31, 2020, https://www.cnn.com/business/live-news/stock-market-news-today-033120/index.html; Maira Rodriguez Validarez, “Market And Macro Data Signal COVID-19 Economic Crisis Will Be Worse Than In 2008,” reporting a DJI decrease of 21.5%, the worst since the fourth quarter of 1987, https://www.forbes.com/sites/mayrarodriguezvalladares/2020/03/31/market-and-macro-data-signal–covid-19-economic-crisis-will-be-worse-than-in-2008/#5bc5d67d6f1e.  
15. Coordinated economic response to the COVID-19 Outbreak, European Commission, March 13, 2020, p. 1, https://ec.europa.eu/info/sites/info/files/communication-coordinated-economic-response-covid19-march-2020_en.pdf.
16. Ibid, p. 1, https://ec.europa.eu/info/sites/info/files/communication-coordinated-economic-response-covid19-march-2020_en.pdf.
17. “The 12 Economic Indicators to Watch,” April 7, 2020, https://www.bloomberg.com/graphics/world-economic-indicators-dashboard/. 
18. George Zarkadakis, “The economy is more a messy, fractal living thing than a machine,” https://aeon.co/ideas/the-economy-is-more-a-messy-fractal-living-thing-than-a-machine.
19. Ibid.
20. Challet, et al., 2009, “The Universal Shape of Economic Recession and Recovery after a Shock,” Economics, Special issue on Reconstructing Macroeconomics, No. 2009-36, Sept. 29, http://www.economics-ejournal.org/economics/journalarticles/2009-36.
21. Economic cases for resilient business leaders, Deloitte, April 6, 2020, https://www2.deloitte.com/global/en/pages/about-deloitte/articles/covid-19/covid-19-planning-scenarios-for-business-leaders-resilient-world-remade.html.
22. Kimberly Amadeo, “2008 Financial Crisis Timeline: Critical Events in the Worst Crisis Since the Depression,” updated November 2019, https://www.thebalance.com/2008-financial-crisis-timeline-3305540.
23. Euromonitor, 2014, “The Recovery from the Global Financial Crisis of 2008: Missing in Action,” Nov. 20, https://blog.euromonitor.com/the-recovery-from-the-global-financial-crisis-of-2008-missing-in-action/.
24. Five years after the onset of the crisis, in 2013 “the investment to GDP ratio was still almost 3-4 percentage points below its pre-crisis level in the U.S., France, Germany and the U.K.,” says Euromonitor, citing IMF data (IMF World Economic Outlook, April 2014). Euromonitor, 2014, “The Recovery from the Global Financial Crisis of 2008: Missing in Action,” Nov. 20, op. cit., note 11.
25. https://www.santafe.edu/