Think at London Business School
Despite records tumbling, the UK government can afford more debt. Here’s how to use it to protect the vulnerable and get the economy moving
By Will Grahame-Clarke
How can policymakers tackle the fear of COVID-19 holding the economy back as we exit lockdown?
This is one of the key questions that Andrea Galeotti, Professor of Economics at London Business School and Flavio Toxvaerd, an alumnus and now Professor of Economics at the University of Cambridge, sought to answer as part of the Wheeler Institute’s UK economy webinar series.
They want to see evidence-based economic policies that take people’s behaviour into account.
Professor Galeotti set the scene by describing the outcome of a game theory experiment that he used to model the spread of the virus. In this pandemic scenario, the risk of infection increased with the number of participants who decided to go out.
In the five-round student experiment, each participant aimed to earn as much fictional money as possible. They were nominally given £100 if they stayed at home. And, if they went out, they received £200, but if they became infected, they received nothing.
Students knew that by staying at home, they would receive the £100 regardless of what the other people did. The students also knew that if they decided to go out, and very few people went out, then the probability of infection would be small, making their average earnings high.
However, if a lot of participants opted to go out, then the probability of infection would be much higher. And therefore, the average earning would then be much lower.
Using the Nash equilibrium, Professor Galeotti predicted the students would elect to go out 40% of the time because, as the game progressed, they would discover this ratio would optimise their earnings. His prediction matched the outcome of the experiment.
Professor Galeotti also found that UK economic consumption prior to lockdown followed a similar pattern to the game. What came as a surprise, is how economic consumption fell in anticipation of the lockdown and didn’t shift lower when lockdown came into effect.
Economic consumption isn’t rebounding because the fear is still there
This is important today because a similar lag in the opposite direction is being experienced as we leave lockdown. Consumption isn’t rebounding because the fear is still there that triggered the fall in the first place.
For Professor Toxvaerd, his work in economic epidemiology is littered with similar examples, where individuals trade off private costs and private benefits when deciding how to behave in the face of infection risk.
Understanding this behaviour matters for the understanding of the progress of an epidemic, but also to make predictions and ultimately to plan properly. This means that policymakers and businesses must take into account several competing externalities in order to plan and react.
History records many examples of how fear has changed behaviour. In a bid to avoid infection the townsfolk of Milan fled the city during the plague of 1639 and probably spread it with them. Every individual private choice has unforeseen wider costs, consequences and benefits that are external to that decision.
Using Google mobility reports, Professor Toxvaerd saw that in this pandemic, the people of Stockholm spontaneously avoided higher risk activities, like train travel, instead staying at home in the first and second weeks of March – even though Sweden had a famously lax lockdown that did not compel citizens to stay at home.
However, if your employer does not support you staying home over and above the statutory minimum, then you might be more likely to just go to work, even when you show symptoms. So, the external cost here is that, when a person isolates, they may not factor into this decision the fact that other people are also influenced by their decision.
We need to understand how one sector enables others to get back to work
So, when people stay at home, there are positive external effects on other people because they don't infect them. But, when there are these externalities and they become understood, Professor Toxvaerd’s research has shown, there is a tendency to under protect. You can see the same dynamic play out with pollution: we know we shouldn’t drive and fly, we might cut back, and yet we make exceptions for ourselves.
A second kind of externality is also at play. Professor Toxvaerd calls this an economic externality. For example, if one person, such as a chef, doesn’t work it can curtail the waiter’s ability to serve the whole menu.
As a society, we would want that person to go to work because it enables every worker in the restaurant to work.
A teacher is an example of this kind of connective role, a role that enables others to work, in this case by allowing parents to work. This person’s value to the wider economy is not reflected in their wage and this individual might not consider the wider economic cost of not working. For a hairdresser, by contrast, there is not the same cost to the economy as the teacher, if they don’t work.
As lockdown ends, policy must reflect these kinds of behavioural and economic externalities, argues Professor Toxvaerd. When policymakers decide which profession to open to business as usual, or to some degree, it is not enough just to weigh that decision on the direct contribution of this economic activity, but also to consider external effects. We need to understand how one sector enables others to get back to work.
For Professor Galeotti, this perspective puts track and trace, within firms, higher up the agenda. In the UK the nationwide system relies on voluntary action when someone becomes symptomatic, effectively asking them to retrace their steps and contact and isolate everyone they’ve met in the previous week. It creates a lot of costs for the individual and therefore increases the likelihood that people might not follow through.
A firm is one scenario where there could be a lot of infectious contact. In football, the English Premier League has invested £4million in track-and-trace programmes. Other sectors may not be so well resourced but may equally infect others. Like an individual, a business must be encouraged by policy, not just to weigh its own costs and benefits, but the costs and benefits to the wider economy.