What socio-economic effects could Covid-19 have in Luxembourg?

What are the likely “direct” effects of Covid-19 on Luxembourg’s economy?

The RECOVid team first points out that in the short-run, damages to national, regional and global economies from Covid-19 are driven by certain “mechanical effects and uncertain behavioral responses”. Necessary measures implemented to flatten the infection curve influence the productivity of the workforce and economic output. If this happens on a global scale, global supply chains may get disrupted, which may influence local economies indirectly. Then of course, if people get sick or in the worst case, succumb to Covid-19, this means fewer people can work or many people will be less productive, at least for a period of time. Last but not least, the public health crisis situation alone can generate panic and (potentially drastic) changes in individual behaviours.

The RECOVid team then provides rough estimates of the short-term effect of the full lockdown on monthly economic output and impact on the 2020 GDP in Luxembourg, stressing the level of uncertainty of their estimations. They run different scenarios, assuming a post-crisis return to normalcy and disregarding the possibility of a systemic collapse of the global/European economy as well as drastic behavioral changes. They state: “The current lockdown could reduce Luxembourg’s monthly output by 28 to 42% depending on the deterioration of the international economy and budget support policy.” In terms of the effect on the 2020 GDP, they estimate that “each month of lockdown mechanically reduces Luxembourg’s annual GDP by 2.0 to 3.5%.”

What sums does this equate to? The RECOVid team has calculated the evolution of the 2020 Luxembourg GDP for a scenario with 34% output loss and in which 1% of the population becomes infected with SARS-CoV-2 (corresponding to a scenario where the virus is well contained): “Under a one-month lockdown, the cost of Covid-19 amounts to EUR 2 billion. Under a two-month or three-month lockdown, the cost reaches EUR 3.9 or 5.7 billion respectively. And the cost of a six-month lockdown amounts to EUR 11.3 billion.” Compared to 2019, “this translates into a 14% decline in GDP, thereby wiping out the benefits of 5 years of massive economic growth.”

The team also estimates which businesses may be most affected: “We assume that lockdown measures decrease [monthly] output:

• by 20% in real estate services as well as in administrative and support services;
• by 50% in the manufacturing industry as well as in transportation and storage services;
• by 90% in construction as well as in wholesale, retail trade and repair services;
• by 100% in accommodation and food services as well as in arts, entertainment and recreation services.

The effects could be greater, for example if cascading effects such as business failures, financial fragilities or a surge in layoffs were taken into account. On the other hand, the effects could also be smaller if the economy turned out to be more resilient and caught up faster.

Finally, the RECOVid team compares this crisis to the 2008 financial crisis and concludes: “Assuming the economy will ultimately get back to normalcy, the recession due to Covid-19 is likely to be deeper than the recession induced by the 2008 financial crisis.”

What can be done to maximize the likelihood of a quick recovery?

“During the lockdown, generous budget support policies are unanimously recommended and have been implemented [in Luxembourg] to relieve corporate cash flow and household income”, the RECOVid team states in their note.

To pay for budget support measures, the government will most likely have to run a deficit and need to borrow. The RECOVid team adopts the argument of French economist Daniel Cohen and recommends: “The major role of public policy in the outbreak phase is not to revive the economy, but to ensure that it remains in a satisfactory state of hibernation, which allows it to recover quickly.[…] To stabilize the system, Daniel Cohen adds that the principle is simple: the deficit must simply be equal to the loss of activity due to the pandemic." In the example of a two-month lockdown, this means that Luxembourg's government could inject 3.9 to 5.9% of its baseline-as-usual GDP in the economy.” The RECOVid group estimates that “while Luxembourg can probably afford this effort, many countries (including European member states) will not be able to cope alone and will need fiscal support.”

Another option put forward by the RECOVid group is “intra-societal transfer”: a worker benefitting financially from the Covid-19 crisis through working at home could – through taxation – help fund the income loss of another worker hit hard by the crisis.

How many families will be impacted in Luxembourg?

In terms of workers at risk of losing income, the team is not in a position to estimate accurate numbers but expresses its “concern that the economic shock is not \socially neutral but will have distributional consequences, hitting the poorest household disproportionately more.”

On the other hand, health professionals work at full speed, which may impact themselves and their families not financially but in terms of welfare.

On that note, the team also calculated how many people may be at risk of mental health issues due to social isolation: “About 45,000 people aged below 60 live alone and about the same number of people aged above 60 live alone in the country. 7 percent of the population, or about 33,000 people still did not have access to internet at home in 2018.”

Finally, with schools closed, children stay at home and so do their parents. The RECOVid researchers have estimated that approximately one in five households in Luxembourg is likely to be impacted by school closures. While some working parents may be able to work from home, not all of them do. But all are meant to take over some educational duties during the lockdown period.

What can be done to minimize the adverse effects of the crisis on inequality, poverty and welfare?

The RECOVid team estimates that “as workers in “lockdown industries” have lower earnings to start with, we may fear a rise in inequality. Very preliminary and provisional estimates suggest that a short lockdown will barely increase poverty rates and inequality indices on the yearly basis.” These estimations are done on the basis that no one loses their job, despite suffering income loss over a period of three months lockdown.

To aid workers in lockdown industries at the highest risk of income losses (e.g. wholesale and retail trade, or accommodation and food service activities), the researchers recommend fiscal measures to compensate for their losses.

The government has already put a number of measures in place to meet short-term liquidity needs, to help individuals and companies with cash-flow problems, to help facilitate corporate lending and to secure job retention. These are meant to help during and after the crisis but do not include all vulnerable employed people. The RECOVid team points out that certain self-employed people, freelancers or people in the event industry are likely to lose substantial business and should therefore be considered too for supportive measures.

In terms of welfare, the RECOVid team does not provide any specific recommendations at this stage but states: “The effect on well-being goes well beyond the monetary impact of the crisis. Welfare losses might be more detrimental for health professionals and for minority groups such as single-person households and households without access to internet.”

What are strategies to exit the lockdown?

An exit strategy was presented by the government on 15 April 2020, proposing a cautious, step-by-step return of people to work places and schools.

In their working note, the RECOVid team recommends massive double testing of employees returning to work. Double testing means that people are both tested for the presence of protective antibodies against SARS-CoV-2 in their blood and for the presence of infectious coronavirus in a nose/throat swab. Only individuals testing positive for antibodies in the blood test (meaning they have been exposed to the virus and should be immune) and negative for virus in the swab (meaning they are no longer infectious) should be allowed back to work. 

According to the RECOVid team, the implementation of double testing is complex for Luxembourg due to the high reliance on cross-border workers. It therefore  underlines that the exit strategy and any testing should be coordinated between Luxembourg and its neighbouring countries.

How high is the risk of a systemic collapse and how can it be mitigated?

The RECOVid group thinks that “the risk of a systemic collapse of the financial system both globally and at the European level cannot be excluded. This would plunge many economies into a persistent recession, with drastic effects on Luxembourg’s economy.”

Their opinion on mitigation strategies to reduce this risk: “Implementing coordinated and preemptive policies such as (i) defining a lender of last resort at the European and national levels and (ii) announcing an unconditional commitment of the EU to support all European economies, would reduce this systemic risk, thereby reducing investors’ fear and guaranteeing that all other fiscal policies remain effective.”

What are potential long-term socio-economic effects, threats and opportunities?

The report also discusses “some “double-edged” mechanisms that can

• either jeopardize the recovery and lead to protectionist and populist pressures... or make global institutions stronger in the longer term,
• either increase global inequality... or induce more solidarity between rich and poor countries,
• slow down technical progress... or accelerate a transition towards a new form of digital capitalism.”

From a longer term perspective, the Covid-19 crisis might lead permanent effects, including the following:

•  slowing down capital accumulation
•  long-term changes in deep personal preferences and in political preferences,
• affect international linkages and cooperation
• lead to a collapse of the neo-liberal model of globalization,
•  and require increasing development assistance.”

Suggestions for future research

The RECOVid team suggests a number of research approaches to extract meaningful evidence-based information about the current crisis. These include:

Adapting or developing modelling tools:

• "to better estimate the macroeconomic effects of the crisis.” (STATEC)
• “to predict the effects of restarting scenarios”, (STATEC)
• “to assess the impact of the lockdown on wage inequality and unemployment across occupations and regions”, (LISER)
• “to assess the distributional effects of a variety of policy interventions to face the Covid-19 crisis” (LISER)

Investigating the cost of non-cooperative actions:

• “Game-theoretic frameworks can be developed to highlightthe benefits and costs of cooperative vs non-cooperative strategies.” (University of Luxembourg)
• Financial systemic risk: “to examine the extent to which the number of households that have not been able to service their mortgages has increased and the extent to which banks in Luxembourg face a risk of increased non-performing loans"

Analysing effects on firms and households:

• “The effect of the crisis on firms’ creation and destruction (exit of so-called zombie firms and/or viable firms, especially small firms and start-up)” (STATEC)
• “whether the crisis induces changes in deep preferences and happiness” and “people's confidence in institutions (trust), openness to globalization and well-being.” (STATEC; LISER; UL)
• “The impact of working from home and the use of new digital tools on workers' subjective well-being and productivity.” (LISER)

Quantifying migration pressures from developing countries: 

“As European countries restart their economies, they will also consider reopening their internaland external borders. What will they do with regard to countries where the Covid-19 is notyet under control?” What impact will this have for the migration of people from developing countries? (LISER)

Normative analysis of non-pharmaceutical interventions:

“How should non-pharmaceutical interventions – social distancing, household quarantine, school and university closure – be designed in terms timing and targeting?” (LISER)

More details in the working note (EN) also available for download on the Research Luxembourg website.