COVID-19 : Production Possibility Frontiers

In an unsettled and uncertain time, Joshua Gans and MIT Press are trying an intriguing experiment: A complete draft of a new book by Gans, Economics in the Age of COVID-19, is freely available on-line.

The draft is going through the standard process of getting comments from outside experts, but up until May 15, you can also read the draft for free and send along your own comments if you wish. The plan seems to be that after May 15, an updated  version of the book taking the comments from outside experts into account will become available for sale, and at some point after that, a final, final version will become available that takes the broader array of public comments into account.

Even when completed, the book will clearly be a first draft of history. But for those of us looking to get up to speed on the considerable amount that has already been thought and written about the economics of the crisis, Joshua has already collected, organized, pre-digested, and exposited a large share of what's out there. In the future, when people are looking back to see what was known and argued when the pandemic was hitting, this book will be a natural starting point.

Here, I'll perhaps do the book a mild disservice by focusing on how Gans uses a familiar tool from intro econ, the production possibilities frontier, to describe the difficulties of making choices curing a pandemic. I should emphasize that this section is not typical of the style of exposition for the book as a whole. Joshua calls it a "Technical Interlude," and writes: "Readers who do not enjoy graphs are free to skip directly to Chapter 2 without missing any crucial information. For economists and other graph lovers, this section will go into more detail of the hollowing out and drift effects so critical to the economic conclusion that health should come before wealth." But for econ teachers wanting a way to bring the pandemic into their classroom (so to speak ...), this part of the discussion offers a way to do so.

Start with this figure showing a tradeoff between the economy and health. The outer line is a standard production possibilities frontier. This diagram should be interpreted as the tradeoff at a point in time. At a point in time, it would be possible to, say, shut down factories and thus to improve air quality, in a way that would reduce the size of the economy but improve health. The blue dot shows the poitn chosen by society. This diagram should be interpreted very broadly, so that "economy" means all of the benefits generated by the economy, not just a simple measure of GDP.

What happens when a pandemic hits? Focus on the left-hand side panel first. Gans argues that the pandemic will mean that the possibilities for both economic output and for health contract. The previous combination of economy and health chosen by society--the blue dot--is no longer feasible. Instead, we have to think about whether we want to absorb the negative impact of the pandemic more through a reduction in the economy, or more through a reduction in health, or with some combination of the two. On the left-hand side of the diagram, point E shows a choice of keeping the economy where it was before, and having all the costs of the pandemic happen via less health. Point H shows a choice of keeping health where it was before, and having all the costs of of the pandemic happen via a reduction in the economy.

The shape of the red line curves has an inward curve, what Gans calls a "hollowing out." What does that shape represent?  Gans writes:

That arises out of the nature of a pandemic. To consider this, suppose that we started from our original level of the economy (at a point like E, the black dot). Then, if we want more health during a pandemic, we need to give up a lot of the economy to get it. This is the social distancing argument — we need a lot of social distancing in order to halt the spread of infectious disease and a little bit won’t have much effect. The same logic applies if we start from our original level of health (at a point like H, the green dot). In that situation, if we look to give up a little health for a better economy we find that we cannot do that. Even to achieve a level of health remotely close to what we previously had, we have to employ lots of social distancing which means that the only way to get a better economy is to give up a ton of health. (Notice that the less virulent is the infection, the smaller the bite is likely to be.) The point is that if we take the epidemiologists seriously then our usual marginal thinking about trade-offs does not work

To put it another way, the shape of the red line emphasizes that trying to muddle through a pandemic with a slightly lower level of health and a slightly reduced economy isn't going to work well. If a society decides that it will choose half-way job of social distancing, it will experience both a big drop in health (because half-way social distancing isn't all that effective) and also a big drop in the economy (because half-way social distancing is still quite costly). A pandemic thus present a kind of either/or choice: choose health or economy, protect one of them, and accept the corresponding costs.

What Gans calls the "drift" makes this lesson even more clear. Imagine that society chooses point E, to protect the economy. As the pandemic advances over time and the health costs become more severe, the economy is going to decline further (as shown by the lower level of point E in the right-hand side of the figure). Also, if society tried to defend the same level of the economy, and thus the pandemic keeps spreading, trying to keep the level of public health more-or-less the same is no longer a workable option. If society wants to protect public health in a pandemic, it needs to act briskly, because the option of protecting public health won't be possible after the pandemic spreads.

Gans presents a series of pandemic PPFs, showing that they are flexible tool for thinking about a range of issues, like how an increased availability of testing would improve the tradeoffs. Intro econ teachers take note!

For the rest of us, this framework helps to explain issues like why the social distancing rules were put in place so abruptly, why trying to take a half-way approach to social distancing would have probably imposed lots of economic costs with few health gains, and why choosing to prioritize health helps to avoid the "drift" that would otherwise occur as the pandemic evolved.

A version of this article first appeared here.