– August 7, 2020
pulling up

The present pandemic has few historical parallels in terms of magnitude. The death count is lower than in these previous episodes thanks to advances in medical knowledge and economic growth that allow us to invest in health goods and services to a greater extent than in the past. 

In fact, the worst policy responses observed failed to generate outcomes that are nearly as bad demographically as those of previous pandemics. Moreover, the same downward trend is observed with regards to the economic costs of pandemics. These trends give us cause for optimism – something which is sorely missing nowadays. 

Nonetheless, are there ways to further reduce these costs? Extreme events like a pandemic are bound to happen here and there as they have in the past. It is thus quite reasonable to wonder how to keep up with the aforementioned trends. 

To see how, consider the following analytical framework in order to understand the ability to deal with shocks (pandemics and other). Before a crisis hits, economic actors organize their production and consumption decisions according to their constraints in ways that make the best of what they get. When the crisis hits, the previous ways of doing things are no longer the best ways. Resources have to be shuffled around to new purposes to produce goods and services that were not valued as much before the crisis. For example, face masks were not in high demand in the past and the firms that produced them did not produce large quantities. With the crisis, the demand for masks increased and the firms had to find ways to get more workers and more capital to ramp up production. The easier it is to reorganize economic activity around the new needs, the lower the economic damages and the lower the death count. 

Essentially, this simple way of interpreting the response to shocks boils down to what we can label “economic rigidity” (for lack of a better term). Some of that rigidity may be due to natural factors (e.g. climate, geography, demographic characteristics of the population). Some of it might also be determined by institutions. 

For example, if a regulation increases the costs of reallocating resources to new purposes, then it creates rigidity. In the present crisis, examples of this abound. For example, federal health regulations in Canada required months of evaluation for the approval of a license to produce hand disinfectant. This is in spite of the fact that the firms that were trying to shift their production to this hand disinfectant were already producing very similar products (distilleries and breweries) and possessed the technical expertise (chemists and testing laboratories). This is only one cog in the machine, but multiply them and the machine slows down enough to notice. 

As such, we should expect institutions that impose fewer regulatory costs and barriers to offer more flexibility. Such institutions make it easier to reallocate resources and adapt to the crisis. 

This insight is what my friend Jamie Bologna Pavlik and I set out to test in a recently published article in Contemporary Economic Policy. We relied on the flu pandemic of 1918 to see if institutional flexibility mitigated the damages of the worst pandemic of the 20th century. We used economic freedom as our main variable of interest. Because the economic freedom variables produced by economic historians included measures of regulation, international trade barriers, property rights protection and sound money, we assumed it was a reliable proxy for this flexibility. 

We found that economic freedom heavily mitigated the damages (measured by excess death rates) of the 1918 pandemic. In other words, an economically free country faced lower economic costs than less free countries with the same death rates. When we decomposed the effects into the different components of the economic freedom measure, regulation levels yielded consistent effects: more regulatory barriers and burdens meant greater economic damages from the pandemic. 

For some, such results may come as a surprise for multiple reasons. However, it is not surprising at all. There are already papers showing that freer economies deal better with economic crises. There are also articles showing that recoveries from hurricanes and other disasters are heavily modulated by the level of institutional flexibility given to entrepreneurs. 

The results also make sense intuitively. Crises such as a pandemic are rife with uncertainty. Knowledge is only generated by trying new solutions. Limiting the ability to try new solutions implies that less knowledge is generated to resolve the uncertainty. This extends and deepens the shock of the crisis. 

Thus, there is an important lesson for the future. If one desires the downward trends in the human and economic costs observed over the course of the 20th century to continue, one must push for a greater deal of institutional flexibility. That flexibility is what makes the market’s process of discovery work and makes us more resilient to future shocks. 

Vincent Geloso

Vincent Geloso

Vincent Geloso, senior fellow at AIER, is an assistant professor of economics at King’s University College. He obtained a PhD in Economic History from the London School of Economics.

Get notified of new articles from Vincent Geloso and AIER.