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Photo: M.B.M./Unsplash/Jonne Renvall

Difficult trade-off between health and economy

The coronavirus pandemic is pushing the global economy into a recession, but is the economic outlook already so pessimistic as to become a self-fulfilling prophecy? Financial experts answer this and other questions and explain why the performance of the stock market affects us all.
7 min
Juho Paavola

No drug, no vaccine, only the anxiety of waiting.

The pandemic outlook is bleak from a medical perspective but veritably positive compared to the financial doomsday scenarios that are now circulated in the media. Financial and corporate executives, politicians and the media are all echoing the same sentiments: recession looms and it will be long and painful. The only question is, how deep will it be?

If recessions are an inevitable part of the economic cycle, is our only choice to accept and adjust?    

Hannu Laurila, university lecturer in economics at Tampere University, finds this question important.

“Mainstream media shape public opinion, expectations and trust and therefore play an overinflated role in the making of long-term agreements. However, the narratives repeated in the media before the coronavirus outbreak did not conjure up the crisis. It was more the other way around,” Laurila notes.

The concept of a self-fulfilling prophecy also applies to economics. When managing our finances, we people may behave in a manner that appears irrational or manic. We invest when the economy is booming and sell our stocks in a panic when the market is down – the exact opposite of what we should be doing. We take out a loan to buy a new car and have a baby when our future appears secure.

“Still, this does not mean that someone, such as a central bank, the government or the media, could propel the economy forward simply through positive talk or push it into a slump by prognosticating about a recession,” says Jari Vainiomäki, professor of economics at Tampere University.

While deterministic economic narrative reinforces our behaviour, what happens despite this narrative is what counts. Due to the volatility of the financial market, economies have always moved in cycles from boom to bust. Accurately predicting the tipping point is impossible; anyone claiming otherwise is lying. 

What have we learned from past crises?

As much as we might want to, we cannot leave the economy on standby as we wait for a cure for COVID-19 and switch it on when the time is right. With our society, industrial production and trade brought to a standstill, jobs will be lost and some businesses will collapse despite government support. Not only the financial buffers of companies but also the savings of consumers will begin to dwindle. 

“When the economy begins to pull out of the slump, productive capacity will not immediately bounce back to pre-crisis levels. There will be fewer jobs than before the slowdown, and new ones will not become available straight away. People who lose their jobs will find it difficult to regain employment, which will prolong the recession,” Vainiomäki notes.

A difficult question that no one wants to delve too deeply into is this: How many deaths are we prepared to accept to limit the economic fallout?

The International Monetary Fund (IMF) predicts the global economy to face its worst downturn since the Great Depression in the 1930s. If it is possible to inject some positivity into economic narratives, it is at least a blessing that the global economy has weathered numerous painful recessions that have taught us important lessons. Vainiomäki says that central banks have learned to respond swiftly to changing circumstances.

“During the recession of the early 1990s in Finland, a steep rise in the costs of foreign currency denominated loans and the collapse of trade with Russia set in motion a wave of corporate bankruptcies with far-reaching consequences. This taught policymakers a lesson, and now the Finnish government is borrowing money and trying to help companies tide over the crisis.”

The economic cost of the coronavirus will not be revealed until years later

The primus motor of the current recession is an invisible virus, but this time the downturn has one positive side effect: since it was brought on by the forced shutdown of a broad swath of industries, the effects can be mitigated by re-opening the economy. In some sectors, there is pent-up demand from delayed spending.  

If the lockdown can be lifted quickly, the recession may be short-lived. This will depend on how quickly a vaccine and specific drugs become available and how soon we can start large-scale testing.  

However, it seems likely that we will have to reopen society before a vaccine is developed or enough people develop immunity through infection to eradicate the virus. Lifting the lockdown will require political decisions that are justified from multiple disciplinary perspectives. 

Tough decisions will be made on health and economy.

“A difficult question that no one wants to delve too deeply into is this: How many deaths are we prepared to accept to limit the economic fallout? Large-scale testing, a selective quarantine strategy and personal protective equipment will help reduce the human cost of the coronavirus if the economy is reopened before a vaccine or a specific drug becomes available,” Vainiomäki says.

Even one death from the coronavirus is too many. If excessive containment efforts send the economy into free fall, the financial viability of our healthcare system will collapse. The number of premature deaths not associated with COVID-19 will increase if we can no longer afford to treat and prevent other diseases. The total cost of the coronavirus pandemic will not be revealed until years later.

Photo: Jonne Renvall

The stock market affects our everyday life

The stock market has tumbled amidst mounting concerns about the economic fallout from the pandemic. Still, when investors buy stocks, not a cent of that money will appear in the company’s financial results. On March 15, the Dow Jones US index fell 12.9%, meaning that companies included in the Dow Jones lost this much of their value in a single day.

Does this matter? After all, a company’s financial performance and ability to pay wages depend on cash flow.

Stock values are important, because they reflect business prospects in the real economy. Stock prices represent the present value of expected profits, but psychological factors also affect the rise and fall of stock prices. This is why stock prices differ from the operational profitability of a company, the so-called fundamental value. Stock prices are a combination of calculations and expectations.

“A market crash means that both the real economy collapses and the speculative bubble built up by unconventional and liquidity-providing monetary policy bursts. The stock market has failed to predict either,” Laurila says.

When the market plummets, investors see the value of their portfolio melt away, but the crash also affects people who own no shares or no slice of a fund.

“In some countries, people have private pension schemes whose value is partly linked to investments in the stock market. A market crash has a knock-on effect on pension schemes and thereby reduces consumer spending,” Vainiomäki says.

Pension funds invest in the stock market in Finland, too, because investment returns help keep employee and employer pension contributions at a moderate level.

“In this system, the downward market will also have implications for the real economy. If the recession drags on, it will become necessary to compensate for lost investment returns by hiking up the contribution rates that employees and employers pay into the pension pot. These increases will, in turn, reduce employment rates and economic output,” Vainiomäki points out.

Psychology plays a role in the stock market, and the stock market has an impact on the real economy. 

A crisis can be an invaluable lesson

Laurila and Vainiomäki agree that there was a growing wedge between reality and investor expectations before the coronavirus outbreak. 

“The crisis has taught us an important lesson. The media has quite extensively and uncritically reported on stock market and property investing, and critical coverage examining who actually benefits from small-scale investing has been largely non-existent,” Laurila points out. 

Stockbrokers have doled out loans to wannabe investors in the past, and many of them have had to sell their investment at a loss already during the early stages of the pandemic. Investing affordable student loans that are intended to cover day-to-day living expenses was encouraged during the economic boom. This worries Vainiomäki.  

“Before the current collapse, stories about people who had successfully invested their student loan appeared in the media. Now these people may be in serious trouble if they lose their job when stock prices are plummeting. The only thing left is the repayment of their student loan,” Vainiomäki says.

For an investor, a crisis does not teach new lessons but reinforces old ones. Temporal and geographical diversification is not a get-rich-quick scheme but will soften the blow when the market drops and help yield higher long-term returns. The safest bet is not to invest with borrowed money.

Before the current collapse, stories about people who had successfully invested their student loan appeared in the media. Now these people may be in serious trouble if they lose their job when stock prices are plummeting.

Spotting the black swan

Nassim Nicholas Taleb coined and popularised the concept of a black swan in his 2007 book. A black swan is an unpredictable, catastrophic event beyond the realm of our normal expectations. The coronavirus pandemic has been called a black swan, but Laurila finds the claim unfounded.

“The coronavirus is not a black swan any more than a stock market bubble. Both risks should have been known and baked into stock prices,” Laurila says.

Vainiomäki has a slightly different view. In the early stages of the pandemic, the market was rattled but did not crash. This shows that the possibility of a more small-scale outbreak of, for example, SARS or Ebola was baked into stock prices – but not the risk of a major pandemic that brings much of the global economy to a halt.

“When the virus found its way outside China and started its rapid spread across the world, panic gripped the market and sent stocks into a steep decline. In this respect, the pandemic was a black swan, an unpredictable event beyond the realm of our usual expectations,” Vainiomäki says.

Considering the cobweb model of global economy, what could foresight have meant in practice? Perhaps stock market professionals could have erred on the side of caution in their valuation analyses, and greater national self-sufficiency and the healthcare system could have been supported through the tax system. On the flipside, these measures would have curtailed economic growth.

The problem with preparedness is that what was too early yesterday is too late today.

“The fact is that climate change, pandemics and other scourges of the modern world are the side effects of capitalist market economy. Besides, the ability of a privatised healthcare system to respond to a pandemic, maintain preparedness and handle a surge in patients needing acute care has deteriorated in a number of countries,” says Laurila.