Governments around the world have responded with unprecedented measures to the spread of the COVID-19. Borders are now closed for travel among most major economies. Drastic policies have been introduced to curtail economic and social activity. The early
evidence so far suggests that they have indeed helped to limit the spread of the virus, but at the same time there are likely to be dire economic consequences
While COVID-19 is a global pandemic, the policy responses so far have been almost
exclusively national. Across Europe, one country after the other closed its border and introduces increasingly stringent domestic containment policies, culminating in lockdowns in most countries. Similarly, in the US, most of the public health response has
been on the local or state level, with little coordination or policy action on the federal level. It takes little if any academic or scientific knowledge to realise that non-coordinated responses are not optimal.
Wolf Wagner and I analyze
the optimality of national containment policies in an integrated world in a paper that has just been published in COVID Economics by CEPR (papers receive a 48 hour review
with up-down decisions). Specifically, we consider a theoretical model with two countries that independently choose their containment policies. We show that while during the containment phase countries might implement policies that are too stringent or too
loose, during the phase of loosening these restrictions, countries will tend to adopt policies that are too loose.
In the short-term, during the lockdown stage, governments face a trade-off between maintaining economic activity and the
costs of a rapidly spreading virus. Critically, there are also cross-border externalities to this decision. Specifically, a lockdown and the shutdown of manufacturing companies will affect supply chains and cause disruption in the production in other countries.
We have seen evidence of this when China shut down large parts of its economy, with negative repercussions on many companies in the US and Europe that depended on Chinese suppliers. There are also demand externalities from these containment policies
as well as negative earnings effects through foreign direct investment channels. These externalities would imply that national policies in this first stage might be too stringent, as individual governments will ignore these cross-border ramifications of their
There are off-setting effects, though. Countries that rely a lot on tourism, for example, might be less willing to adopt stringent containment policies and might rather be on the side of waiting rather than acting too quickly.
We provide suggestive empirical evidence for that, relating containment policies across 27 European countries to death rates and their reliance on merchandise trade and tourism. We show that countries relying more on merchandise trade “produce”
externalities for other countries and thus opt for rather more stringent lockdown policies, while countries relying more on tourism will delay lockdown as much as possible.
The more successful the suppression of the virus has been, the
lower the costs of the virus during the new-normal stage of our model. In the new-normal phase, externalities will be predominantly coming through the cross-border spreading of the virus rather than economic channels. We assume that at this stage, borders
are open, allowing people to travel internationally. Direct disruptions in the production process from curtailing production in the other country are thought to be of less relevance then, because production processes will have adjusted; firms will have modified
their supply chain and countries will have become more autarkic. This implies that during the new normal, containment policies may be excessively lenient, and in particular so in countries that have a high mobility (inward and outward), such
as popular tourist destinations.
These externalities call for urgent international cooperation, to internalize the externalities discussed above and help flatten both the medical
and the economic curves.