Businessman remove one piece from jenga tower Risk management concept metaphor

This article appears in the June 2020 issue of Investment Executive. Subscribe to the print edition, read the digital edition or read the articles online.

The economic impact of efforts to contain the spread of Covid-19 will prove immense. The latest data from Statistics Canada reveal “unprecedented declines” in the Canadian workforce, as employment dropped by three million people and hours worked plunged by 30% between February and April.

Initial assessments of the impact on economic output continue to be revised downward. New York-based Fitch Ratings Inc.’s latest forecast states that the rating agency anticipates Canada’s GDP will contract by 7.1% this year — and gloomier forecasts warn of a double-digit drop in annual GDP.

These dire outlooks assume that a gradual reopening of the economy takes hold in the second half of 2020 as lockdowns ease and economic activity picks up. The nightmare scenario for the economy is that infection rates spike after restrictions on business activity are lifted and the country is plunged back into a shutdown, compounding the economic devastation already being wrought by the initial response to the pandemic.

Given that an effective, widely available vaccine is probably at least a year away, the potential for a second wave of Covid-19 infections appears almost inevitable.

If and when that happens, governments hopefully will be prepared to take a more flexible approach to containing the virus rather than resort to economically devastating, comprehensive lockdowns once again.

“Placing the economy in a partial coma made sense during the first wave of the pandemic, but if there is a second wave, a second economywide shutdown should be avoided in favour of more targeted approaches,” stated a release from a working group convened by the C.D. Howe Institute.

That group — co-chaired by David Dodge (formerly governor of the Bank of Canada) and Mark Zelmer (formerly deputy superintendent of the Office of the Superintendent of Financial Institutions) — argues that governments must take a more measured approach to combating a resurgence in infections, given the economic damage inflicted by the initial outbreak and the threat to Canada’s already battered public finances.

Recent estimates from the Parliamentary Budget Officer of Canada in Ottawa indicate that the federal deficit for 2020–21 could be more than $250 billion — a tenfold increase over pre-crisis projections and about 12.7% of GDP for the fiscal year that began April 1.

Not only are federal finances taking a beating, but the Bank of Canada has tripled the liabilities on its balance sheet over the past couple of months with the launch of an array of emergency support measures, including programs to keep provincial and corporate bond markets functioning.

The provinces are suffering as well. A report from Montreal-based National Bank Financial Inc. estimates that provincial governments are facing a combined $100-billion deficit this year. That is on top of the massive federal deficit.

While the initial shutdown due to the pandemic came at a massive cost, new research indicates that more targeted intervention can lead to better results in terms of both health and the economy.

A recent paper from the Federal Reserve Bank of Minneapolis (FRBM) stated that a combination of targeted testing for the coronavirus and isolation has the potential to provide a much better outcome by inflicting less damage on economic activity — while also doing a better job of saving lives.

According to the FRBM’s model, an economic shutdown that causes a short, severe recession is better than simply permitting a pandemic to flourish unchecked. A shutdown, while damaging, generates a 0.6% permanent increase in consumption (due to reduced spread of the virus and fewer deaths) compared with doing nothing.

However, when testing and isolation tools are introduced, the result is a 3.0% gain, as this approach produces much less severe economic damage and does a better job of preventing deaths.

“Our findings also suggest that even if a pandemic is well underway, testing and isolation policies are very valuable,” the FRBM paper concluded.

Governments didn’t prefer indiscriminate lockdowns when the virus initially emerged. However, at the outset, there wasn’t much choice. Most governments simply weren’t capable of the sort of testing, tracing and isolating that could produce less destructive results than those of a wholesale lockdown.

Covid-19 also has proven trickier to contain than previous pandemics, such as SARS, because a significant share of Covid-19 infections do not develop symptoms, allowing carriers to spread the virus unknowingly. But, as testing capacity increases, the possibility of catching and isolating asymptomatic spreaders improves.

Moreover, as the body of research into the virus’ spread continues to grow, so does policymakers’ understanding of the relative risk of various activities. While isolating with immediate family and limiting outside contact strictly is the safest approach, several key factors — indoor vs outdoor activity, prolonged vs short-duration exposure, small vs large groups of people — are critical in determining the level of risk of infection.

Armed with this sort of information, governments can make more nuanced decisions about the limits to set on economic activity. Large, prolonged indoor gatherings may have to remain off-limits, but lower–risk endeavours may not have to be treated similarly. Enhanced testing for the virus and tracing of infection paths also could enable more targeted curbs. Therefore, comprehensive lockdowns may not be the only option if evidence of a second wave emerges