The COVID-19 virus has infected populations around the world and slammed the global economy. While it is unclear where the coronavirus pandemic is headed, experts believe that it will lead to a worldwide recession.
Mauro Guillen, professor of international management at Wharton and the creator of an online course on the coronavirus crisis that the school plans to launch on March 25, believes that the challenge on the economic front is whether policy makers can find a way to prevent firms from laying off workers and if they can help calm panicky markets.
As more state governments in the U.S. have adopted a shelter-in-place strategy in recent weeks to contain the pandemic’s spread, media reports suggest that the Trump administration might be cooling off on the idea. Predictions that unemployment in the U.S. could jump to more than 20% and a Goldman Sachs forecast that GDP could shrink by 24% in the second quarter is believed to have prompted rethinking about social distancing. Guillen, however, believes that the U.S. could learn from China’s experience in this regard. “The Chinese experience indicates that social distancing and shelter in place work,” he says.
In a conversation with Knowledge at Wharton, Guillen discusses the state of the pandemic, the response of governments around the world, and some lessons learned so far. “We need to rethink the implications of this interconnectivity that we have in the world and see whether we have made our economy prone to disaster just because we have been emphasizing efficiency too much,” he says.
An edited transcript of the interview appears below:
Knowledge at Wharton: The coronavirus pandemic has swept around the world with astonishing speed. Things seem to be changing every day, if not every hour. What is your assessment of the crisis as it stands today, and where is it headed?
Mauro Guillen: From a public health perspective, this is a global crisis. It is a pandemic with many different instances of local transmission of the virus. From an economic and a financial point of view, it’s a crisis that has infected financial markets, particularly the equity markets, and it threatens global supply chains. I think it would produce a recession — a worldwide recession — especially in the countries that are the most affected by the virus. The impact has been sudden. I think it will persist for a few weeks, if not months.
Knowledge at Wharton: Some people say that the markets are overreacting, and this is going to be a sharp but short recession. Another point of view is that we have not yet seen most of the impact and this is likely to last much longer. What is your view?
On the economic front, the challenge is whether policy makers will find a way of preventing small or medium-sized firms from laying off workers.
Guillen: I think we must consider different scenarios. In terms of the public health or epidemiological aspects, we still don’t know how the virus is going to behave once we put in place social isolation or social distancing methods that many governments around the world are implementing. We also don’t know how the virus will respond to higher temperatures in the northern hemisphere once we move to spring and summer. How good or how bad this will be depends partly on that.
On the economic front, the challenge is whether policy makers will find a way of preventing small or medium-sized firms from laying off workers. Depending on the country, between 40% and 60% of employment is in smaller firms. If those firms go bust, or they have to lay off workers, then that’s going to have a negative multiplier effect across the economy. When people lose their jobs, they spend less. In some cases, they get no income or they get unemployment subsidies but they spend less. We are in a consumer-oriented economy. Around 65% of GDP is consumption. If large numbers of people get unemployed, then that’s going to have a ripple effect throughout the economy. That, in turn, will also make investors much more pessimistic about the future.
Knowledge at Wharton: In the U.S., the Federal Reserve recently cut interest rates almost to zero. It also announced a series of other steps to ease the crisis and bolster the economy. But the markets in Europe and the U.S. have not been reassured. Do you think these steps are enough? What else should the government be doing?
Guillen: We need to understand the psychology of the markets. When the markets see that the Federal Reserve has taken such extreme measures as cutting rates to nearly zero, [they think] that this will help the market. But at the same time, they realize that if the Federal Reserve is willing to go so far as to cut interest rates to near zero, the problem is more serious than they thought.
The other factor is that it’s not yet clear how investors should price the risk. Right now, what we have is a lot of uncertainty. And remember, uncertainty is the situation in which we don’t know how to calculate the probability of different scenarios in the future. What we need is for investors to find a way to price the risk of assessing in a quantitative way what the exposure is going to be, and how long it might take for the economy to come back. But right now, those conditions are not there. That’s why I think we see the markets going down 10% one day and then the following day coming up 5%. Investors are looking for clues or information as to how to price the problem.
Knowledge at Wharton: In your view, how should the risk be priced?
Guillen: The single most important thing to do is for investors first to calm down. For instance, most of us have investments in the stock market in the form of pension funds. Unless we are retiring in the next five years, I don’t think we should be concerned about this downturn. Secondly, much of what’s going on right now may be driven by speculators or investors who could easily put their money into other asset classes such as bonds or gold or perhaps private equity. We need to distinguish between those who have long-term interests in the stock market and other investors who are looking for a short-term gain. Those who are thinking about alternative investments right now need to reassess their positions. You can lose money in the stock market but you need to have more of a longer-term perspective.
Knowledge at Wharton: Do you think that algorithmic trading platforms are also playing a role in contributing to the volatility that we see in the markets?
Guillen: I hear from experts that there’s a lot of computer-based automatic algorithmic trading going on. That’s why a number of years ago we introduced the emergency fuse switch whereby if the Dow or the S&P 500 dropped by a certain percentage point of the markets opening, or during the trading day, then trading would be suspended for a few minutes. The trouble is that since this crisis started, the switch has been activated [multiple] times.
Knowledge at Wharton: The circuit breaker, as they call it….
Guillen: Yes, the circuit breaker. It’s important to again put things in perspective. For most of us what really matters is the long-term performance of the stock market. It’s not these short-term gyrations. Having said that, a lot of wealth has been destroyed already and there’s more to come. But let’s also puts things in perspective. The stock market is today where it was a year and a half ago, or two years ago. So, in most cases, what we’re seeing is paper gains essentially dissipate, right? Those gains never materialized because there are a lot of long-term investors in the market.
Knowledge at Wharton: Since the crisis began in China, what is your assessment of the way in which the Chinese government responded both to the health issues, as well as to the economic issues sparked by the pandemic?
The single most important thing to do is for investors to calm down.
Guillen: The Chinese government at all levels has been improving its response. During the first six weeks or so, the response was awful, in the sense that they kept it quiet. They didn’t inform people in China or outside of China. I’m talking about November, December, early January. Then they started to think more carefully about the threats implicit in this virus. They put in place draconian measures that I’m hoping we will be able to avoid here in the United States.
But it was already too late for some other countries, like Italy or Iran. Or now Spain, and possibly France, where the number of cases has been growing exponentially. So, I would praise the Chinese for realizing at some point that they needed to inform the world, and they needed to be transparent about this. But I would hope that next time they do become transparent from day one, as opposed to a few weeks into the epidemic.
Knowledge at Wharton: Has China done enough? What could the country have done differently?
Guillen: It seems that so far there are two countries that have been able to bring the virus under control without implementing harsh measures: Singapore and South Korea. Hong Kong has also done a reasonably good job. China apparently has already been able to reduce the rate of growth of the epidemic. While new cases are being reported, each day the number of new cases is smaller than the day before. That means the methods are working out.
These three governments — Singapore, South Korea and China — have different kinds of policies. All of them seem to have worked so far. There are some differences in terms of how harsh the measures have been, in terms of how it will change the lives of people. What we don’t know yet is the full impact of the virus in China in terms of the economic implications. We still don’t know by how much GDP growth will be reduced, or even if the Chinese economy could enter a recession, which would be unprecedented.
Knowledge at Wharton: Many commentators have praised the way that Singapore and South Korea have dealt with the crisis. What are some of the steps that they took? What could other countries learn from their experience?
Guillen: It was essentially three things. The first one is test, test, test and test. You need to know where the contagion is taking place. You need to contain the virus at that point. Number two is, make sure that your health care system is ready for the cases. That means hospital beds. That means personnel. That also means certain kinds of equipment like respirators. The third is to convey, communicate very clearly to the population, “This is what you need to do if you want to avoid being affected by the virus.”
In many countries there is a lot of confusion about what every person should do. Should they wear masks? Should they wash their hands more frequently? Should they avoid large gatherings? Some of those things are more important than others. We know now that it is far more important to wash your hands than to wear a mask. So, I think those are the three things. Test, prepare the health care sector, and then lastly communicate clearly to the population what it is that they need to do.
Knowledge at Wharton: How do you view the response of governments in Europe? You mentioned Italy, Spain and France. Have they been taking the right steps?
Guillen: They have now, up to a point. But it’s too late. Once Italy got into a lot of trouble, the writing was on the wall for the rest of Europe. Europe is a borderless area, at least until now, with a lot of flights, a lot of people moving around. Once they saw the problem in Italy, they should have acted faster in terms of taking or adopting measures. What they haven’t done either, so far, is come up with a fiscal response to the crisis. Especially also helping the small and medium-sized enterprises.
Imagine that in the United States, we have Ohio being like Italy, with mounting cases and all of that. But then the other 49 states essentially waiting to see what happens, as opposed to taking measures. That would have been a big disaster, right? So far, we have avoided that in the United States. But in Europe, with such an integrated economy, about three weeks ago or four weeks ago when it became readily apparent that Italy was in big trouble all of the other countries — not just the neighboring ones, all of the other countries in Western Europe — should have taken more decisive action.
The U.S. has suffered in a way from the same problems as in Europe [with] containing the virus itself. We have done a much better job from the point of view of containing the economic and business impact.
Knowledge at Wharton: Is there anything else that the European governments should be doing that they have not yet done, in your view?
Guillen: The single most important thing right now, as I said, was to test, test, and test. They’re doing a far better job in Europe than we are here in the United States. The second one is the health care system. It seems as if they are a little bit lagging behind in terms of making sure that the health care system is ready and creating more capacity. In some countries, they’re using hotels. They’re trying to equip hotels with the necessary devices for the milder cases of the disease, reserving the hospital beds for the more serious cases. Lastly, as I was mentioning earlier, it’s only been recently that people in France or in Spain, for instance, have been told clearly, “This is what you’re supposed to do.”
Knowledge at Wharton: What is your view of the way in which the U.S. government has responded to the crisis?
Guillen: The U.S. has suffered in a way from the same problems as in Europe. There is lack of coordination when it comes to the epidemiological aspects — containing the virus itself. We have done a much better job from the point of view of containing the economic and business impact. The Fed has acted very swiftly and quite drastically by reducing interest rates down to nearly zero. I take it that the Treasury Department and the Congress will agree on some kind of a fiscal plan for small and medium-sized companies. And also perhaps some bailouts for industries that are going to be directly affected, such as tourism, airlines, cruise lines, and so on.
These are industries that employ a lot of people and you want to avoid job losses. I was expecting this. I was expecting that on the economic front we will do a much better job because back in 2008 with the financial crisis, we were so much more effective than Europe. But now we have another ingredient here, another side to this, which is the epidemiological issue. This was completely absent in 2008. I believe that in countries like Singapore or South Korea, perhaps also in China, they have done a much better job than we have so far in this aspect.
Knowledge at Wharton: What are the main lessons learned so far from the way in which governments have responded to the crisis, that can play a role in helping us deal with crises in the future?
Guillen: Unfortunately, we have learned very little. We live in an interconnected world. Even within a country such as the United States, everything is interconnected. Over the last 20 years or so, there has been too much of an emphasis on being very efficient. We have reduced all the buffers in the system, all the duplications, because they’re costly. Companies are operating with zero inventories, supply chains are run on a just-in-time basis, and so on.
Such a fine-tuned system, that is very efficient, works very well when conditions are stable. But if you get a major shock or a disruption, such as a public health crisis or let’s say the earthquake and tsunami in Japan a few years ago which disrupted global supply chains and the global economy, then it’s like an accident waiting to happen. During normal times, everything works really well. But if there’s some kind of disturbance — it could be an earthquake, it could be a hurricane, it could be an epidemic or it could be a terrorist attack, for example — then, you get into a lot of trouble. We need to rethink the implications of this interconnectivity that we have in the world and see whether we have made our economy prone to disaster just because we have been emphasizing efficiency too much.
What’s important is that from now on, all of us as individuals, companies, organizations, the government — we all do the right thing. Sometimes there’s debate as to what the right thing is, but now we certainly have awareness. People are keenly aware of the fact that this is a serious issue.
