Question

What does the literature about skill biased technological change tell us about the potential economic

impacts of COVID-19?

Answer 1

To understand the potential negative economic impact of COVID-19, it is important to
understand the economic transmission channels through which the shocks will adversely
affect the economy. According to Carlsson-Szlezak et al. (2020a) and Carlsson-Szlezak et al.
(2020b), there are three main transmission channels. The first is the direct impact, which is
related to the reduced consumption of goods and services. Prolonged lengths of the
pandemic and the social distancing measures might reduce consumer confidence by keeping
consumers at home, wary of discretionary spending and pessimistic about the long-term
economic prospects. The second one is the indirect impact working through financial market
shocks and their effects on the real economy. Household wealth will likely fall, savings will
increase, and consumption spending will decrease further. The third consists of supply-side
disruptions; as COVID-19 keeps production halted, it will negatively impact supply chains,
labor demand, and employment, leading to prolonged periods of lay-offs and rising
unemployment. In particular, Baldwin (2020) discussesthe expectation shock by which there is a “wait-and-see” attitude adopted by economic agents. The author argues that this is common during economic climates characterized by uncertainties, as there is less confidence
in markets and economic transactions. Ultimately, the intensity of the shock is determined
by the underlying epidemiological properties of COVID-19, consumer and firm behavior in the
face of adversity, and public policy responses.
Gourinchas(2020, p. 33)summarizesthe effect on the economy by stating: “A modern
economy is a complex web of interconnected parties: employees, firms, suppliers, consumers,
and financial intermediaries. Everyone is someone else’s employee, customer, lender, etc.”
Due to the very high degrees of inter-connectiveness and specialization of productive
activities, a breakdown in the supply chains and the circular flows will have a cascading effect.
Baldwin (2020) describes the impact of COVID-19 on the flows of income in the economy.
First, households do not get paid and hence reduce their consumption and savings levels. The
decrease in savings reduce investment and hence ultimately diminish the capital stock.26
Second, households reduce their demand for imports, which in turn reduces income for the
rest of the World, and hence the country’s exports decrease. Third, the demand/supply
shocks cause disruption in domestic and international supply chains. Fourth, all of the
previous shocks and disruptions lead to a fall in output – causing reductions in the usage of
the factors of production. In this case, labor is more affected than capital through reduced
working hours or layoffs and hence lower earnings
It is also important to understand the processes that generate recoveries from
economic crises. Carlsson-Szlezak et al. (2020a) explain different types of recovery after
shocks through the concept of “shock geometry”. There are three broad scenarios of
economic recoveries, which we mention in ascending order of their severity. First, there is
the most optimistic one labelled ‘V-shaped’, whereby aggregate output is displaced and
quickly recovers to its pre-crisis path. Second, there is the ‘U-shaped’ path, whereby output
drops swiftly but it does not return to its pre-crisis path. The gap between the old and new
output path remains large. Third, in the case of the very grim ‘L-shaped’ path, output drops,
and growth rates continue to decline. The gap between the old and new output path continues to widen. Notably, Carlsson-Szlezak et al. (2020b) state that after previous
pandemics,such as the 1918 Spanish Influenza, the 1958 Asian Influenza, the 1968 Hong Kong
influenza, and the 2002 SARS outbreak, economies have experienced ‘V-shaped’ recoveries.
However, the COVID-19 economic recovery is not expected to be straightforward. This is
because the effects on employment due to social distancing measures/lockdowns are
expected to be much larger. According to Gourinchas (2020), during a short period, as much
as 50 percent of the working population might not be able to find work. Moreover, even if
no containment measures were implemented, a recession would occur anyway, fueled by the
precautionary and/or panic behavior of households and firms faced with the uncertainty of
dealing with a pandemic as well as with an inadequate public health response (Gourinchas, 2020)