How much will the shutdown of the Danish economy during the corona crisis cost?

In scenario 1, the disease will either lose its foothold by itself or could be kept in check with measures aimed at infected individuals and particularly vulnerable groups after the first wave. However, in scenarios 2-5, the disease is only assumed to lose a foothold after 60% of the population is infected, or (scenario 5) when a vaccine is found. In scenarios 2 and 3, the disease is assumed to lose a foothold already after 5-6 months, with the second wave significantly increasing both the number of infected individuals and the capacity of the healthcare system. However, in scenarios 4 and 5, the number of infected individuals is limited to 100,000 at a time until the virus loses its foothold. This corresponds roughly to the level during the first wave expected by the Danish Health Authority. Currently, significantly fewer people are thought to be infected.

3. The shutdown is a supply shock
Shocks to economic activity may come from both supply and demand. The shutdown is a negative supply shock to the Danish economy and the shutdown in many other countries is a shock to the global economy. The decline in economic activity is due to the shutdown preventing a number of industries from manufacturing as usual. The supply shock is followed by a corresponding decline in incomes and, on a global level, will cause demand to fall just as much as supply falls. Seen from the individual firm , it will naturally look like a demand shock because customers fail to appear. However, that does not change the fact that it is the decline in the production capacity of the economy as a result of the shutdown that is the real reason for the fall in demand.

It is well known that the fall in income due to a supply shock cannot be avoided with economic policy tools that affect the demand side. On the other hand, political initiatives may affect the distribution of the income loss.

The corona crisis is a very different shock from the financial crisis, which, in addition to monetary policy impulses, was triggered by the freezing of the banking sector and the supply of liquidity in particular. However, the latter also had the traits of a supply shock, which could be limited by supplying liquidity from central banks and the national treasuries (in Denmark by guaranteeing banks with funding problems as well as extending payment deadlines for VAT and tax paid on regular income[1] ).

The supply shock resulting from the corona crisis may have a number of consequences. First, the supply shock can spread to the demand side. The problem is not lessened by the fact that, even before the crisis, the business cycles looked fragile globally: Countries such as Japan, France, Italy, Hong Kong and South Africa had negative growth in the fourth quarter of 2019, while countries such as the UK, Germany, Canada and Sweden had stagnation or low growth. The euro area’s growth was 0.5% p. a. in the fourth quarter. In addition, there were speculations that stock prices were overvalued; after the corona crisis started, there have been significantly greater corrections than this crisis could justify on its own (otherwise, the fall in prices signals expectations of a very strong supply shock, indeed).

Second, the crisis can create adjustment problems if companies become insolvent and have to find new owners, and the losses must be distributed to creditors. The government has introduced a number of subsidies that compensate for some of the solvency losses. It may mitigate any adjustment problems, but it is important to emphasise that the losses will simply be redistributed to some others and that may also have negative effects on the overall economy. This also applies if the government debt increases.

However, it is also well known that economies often recover very quickly even after major supply shocks such as natural disasters that cause material destruction of the capital stock. Therefore, the size of the supply shock is of independent interest because it is more certain than the derived consequences. In addition, the supply shock itself cannot be mitigated by short-term economic policy, or, in Denmark’s case, by the effect of monetary policy in the euro area and the very large automatic stabilisers. Even in a situation where there is a need for short-term economic policy, it will not necessarily require discretionary measures because we conduct through the fixed exchange rate policy the same monetary policy as the euro area (unless the krone comes under pressure) and because public spending and tax revenue are among the most sensitive to business cycle fluctuations in the EU.

Et rent udbudschok bør ikke ventes at få varige konsekvenser, medmindre det sætter sig i struk-turelle forhold som beskæftigelse eller offentlige finanser. I Danmark er de offentlige finanser holdbare, mens konsekvenserne kan blive alvorlige i lande med i forvejen svage offentlige fi-nanser, herunder i eurolande som Italien. En genopblussen af statsgældskrisen i euroområdet kan ikke udelukkes.

A pure supply shock should not be expected to have permanent consequences, unless it affects structural levels of e.g. employment and government debt. In Denmark, public finances are sustainable (technically defined), but the consequences could be serious in countries with initially weak public finances, including euro countries such as Italy. A reemergence of the government debt crisis in the euro area should not be rules out.

4. One month’s shutdown costs almost 1½ % in annual economic growth.
The following is a calculation of what the aforementioned scenarios will entail on the supply shock to the Danish economy. The calculation is based on a number of simplifying assumptions. It is important to stress that this is not a model prediction or an actual forecast.

The shutdown impacts different industries in widely varying ways. A number of service industries such as hairdressing and bar keeping will be practically impossible to conduct. On the other hand, manufacturing industries as well as agriculture and forestry have largely been exempted from the shutdown. Some activities, including in the education sector, are being carried out online and through work from home.

A rough score has been made for how individual industry’s gross value added will be affected by the shutdown (see appendix). The baseline is the industrial distribution of gross value added in 2019. The intention is not that the individual industry score is accurate, but to ascertain a picture of the average overall impact. Despite widespread sending home of employees, public service is assumed to be at normal capacity because this part of public spending is calculated input-based in the national accounts and because those sent home receive pay.

Under these assumptions, production capacity measured by gross value added is estimated to decrease by 17.2% during shutdown compared to normal production. Converted to a monthly basis, this means that immediate effect of one month’s shutdown is a reduction in the annual economic growth by 1.4 percentage point.

It is also assumed that this immediate impact is proportional to the number of months of shutdown in the five scenarios. This applies regardless of the fact that in the long shutdown scenarios there is room for some easing of the shutdown (e.g. reopening of kindergardens and border passage), as growing immunity reduces infection levels. Also, technological adjustmenst could emerge, allowing some activities, which have been hampered by the shutdown initialy, to take place within the limits of the shutdown. E.g. working from home could become even more commonplace. Both relaxing the shutdown and the emergence of new technological solutions would reduce the adverse economic effect over time. On the other hand, a prolonged shutdown will cause bottlenecks in both sales and staffing, and even in sales for those industries not directly affected by the shutdown. For example, the industry may be affected by an increasing number of people calling in sick due to infection and quarantine, as well as absence from work for the purpose of childcare. It may also have growing problems in the sales of its manufacture, although it delivers to a limited extent the industries that are shutdown at home and abroad. All things considered, the two effects are assumed to offset each other, so the effect on growth is directly proportional to the length of the shutdown.

However, it will be possible to catch up with a portion of the production backlog after the shutdown, especially for shorter durations of shutdown. This effect is also well known, albeit the magnitude will depend on many conditions. Specifically, it is assumed that production can be increased by 5% above the normal level for one quarter after the shutdown has ended (roughly in line with excess capacity at the outset of the crisis).

Table 2 shows the main results of the calculation for the five scenarios

The supply shock in scenario 1, where the shutdown is limited until summer, can thus be calculated at DKK 78 billion in factor prices or a fall in growth in 2020 by 3.8 percentage points. The Danish Ministry of Finance’s forecast from December projected a growth of 1.3% by 2020. In this scenario, this growth will instead fall by 2.5%. (1.3% minus 3.8%).

In scenario 4, where the shutdown lasts well into 2021, the total growth loss in 2020 and 2021 will be over DKK 500 billion. The declining growth rate is respectively 14.4% and 10.2% in those two years. Given the expectation of growth of 1.3% in both years, we will experience negative economic growth of 13.1% and 8.9% in those two years. It will be a very huge recession. In scenario 5, the shutdown continues until a vaccine is developed. This does not allow for the same gradual relaxing of the shutdown as in the case of developing herd immunity. The losses associated with scenario 5 should be regarded as very conservative estimates, and both scenario 4 and 5 are much more uncertain than 1-3.

Compared to the extreme scenarios, scenario 3 with six months of shutdown shows a total production loss of just over DKK 150 billion (in factor prices) in 2020. This corresponds to a decrease of 7.3%, so that the recession will be 6.0%. By comparison, gross value added fell by 4.4% during the 2009 financial crisis.

It is extreemely difficult to estimate the effect of the supply shock on employment and unemployment. The immediate drop of 17% gross value added is associated by a drop in the use of labour by 20%, measured both by heads and working hours. That would translate to 500,000 employees. Unemployment and registered employment would not, however, fall by nearly the same, since falling activity does not normally lead to a comparable amount of redundancies. Furthermore, special subsidies to firms during the crisis will play a limiting role

During the financial crisis, employment fell from 2008 to 2009 by 92,600 persons, or 3.1%, while gross value added fell by 4.4%. That translated into a fall of 20,000 person per percentage point drop in gross value added. Assuming a comparable fall associated with the shutdown, employment will fall by approx. 125,000 persons in scenario 3. This effect must be seen as more uncertain, however, and furthermore there is traditionally a lag between aggregate production and employment. This was the case during the financial crisis too.

5. Conclusion
The calculations performed in this analysis suggests that the shutdown related to the corona crisis will result in a supply shock to the Danish economy, which depending on the duration of the shutdown will lead to a larger recession than during the first year of the financial crisis. In the medium scenario, economic activity will fall by 6% in 2020.

It is important to note that this is a first estimation of the possible orders of magnitude of the economic consequences. The method should be refined and developed in light of new experience from the development of the epidemic. Notwithstanding, the amounts are so large that is paramount that the government develops and publishes estimates for the economic consequences of both already decided and possible new policies.

6. References
Ferguson, N.M., Laydon, D., Nedjati-Gilani, G., Imai, N., Ainslie, K., Baguelin, M., Bhatia, S., Boonyasiri, A., Cucunubá, Z., Cuomo-Dannenburg, G., Dighe, A., Fu, H., Gaythorpe, K., Thompson, H., Verity, R., Volz, E., Wang, H., Wang, Y., Walker, P.G., Walters, C., Winskill, P., Whittaker, C., Donnelly, C.A., Riley, S., Ghani, A.C., 2020. Impact of non-pharmaceutical interventions (NPIs) to reduce COVID- 19 mortality and healthcare demand 20.
Sundhedsstyrelsen, 2020a. COVID-19: Risikovurdering, strategi og tiltag ved epidemi i Danmark, version 10. marts 2020. Sundhedsstyrelsen.
Sundhedsstyrelsen, 2020b. COVID-19 i Danmark – Epidemiens første bølge. Status og strategi. version 23. marts 2020.

Fodnoter

1. The parliament has also extended payment deadlines for VAT and tax paid on regular income during the corona crisis, but it is hardly as relevant as during the financial crisis, because this time there is no liquidity crisis