The Coronavirus Externality Problem

The solution to a problem is often a function of how it is characterized. Economists in the field of public finance have historically had a way to characterize spillovers, where there are benefits or costs that people get inadvertently impacted by as a result of other people's assumedly private choices.

We call them externalities. The novel coronavirus - COVID-19 - is a prime example of a negative externality.

Let us suppose that Damien, who lives in Seattle, Washington, just got back from a hell of a trip abroad where, amongst other exciting adventures, he experimented with exotic foods and for some unspecified reason upon returning finds that after a couple days he has symptoms which ultimately test positive for the novel coronavirus (COVID-19).

Prior to this time, he mingled with friends abroad, went to a night party just before his trip back and interacted with passengers as he waited to board his flights back that included two stopovers and long wait times, during which time he had close interactions with others; and after he arrived, he went visiting his colleagues at work, passing his phone to each one to scroll through the pictures he took, then he goes to visit his mother who is in a nursing home interact with other patients and staff there and shows them the pics he took while making small talk.

The usual, normal behavior of anyone who has just returned from an exciting trip and wants to share that experience.

However, Damien has potentially infected several people even while he was infected and did not show any symptoms. A few days after some of these individuals find themselves having the symptoms of the disease and ultimately test positive, but they also have in the meantime had multiple interactions with others...

For the most part Damien was simply involved in a private economic activity - Enjoying a trip abroad, sharing that experience with others, and meeting his social obligations in being a friendly coworker, checking on his mom, and interacting with others in society. Private in the sense that these were his choices, intended to bring him some measure of satisfaction, while posing no costs on anyone else that was not covered through some financial payment. Yet others have now been harmed by his choice, and they also have similarly harmed others by their own private choices.

Damien is not going to be liable for making those unwitting travelers or his coworkers, or the staff at the nursing home sick, neither will those infected be held liable for those subsequently infected by them. However this is a negative externality situation - others are harmed by the innocuous private choices made by entities, and they are not being compensated for it.

Ordinarily the negative externality problem could be addressed through a policy that for instance places a tax on the activity equal to the marginal social damage - the externality cost at the margin, but what happens here where the costs increase exponentially and every subsequent infected person bears a responsibility for the total amount of damage caused to society?

Prohibitive Marginal Damage Scenario

I call this a prohibitive marginal damage scenario because with a rapid increase in the number of people infected and with the harm associated with the coronavirus which includes death for some populations, we have a situation where the economic solution to the problem would be to ban the activity - analogous to having people pay a prohibitively high tax to be able to interact with others in society. In this case that means putting restrictions on interactions with others, as we have in place now. Currently the national policy is restricting gatherings to no more than ten people in a place at a time.

Interestingly, when we hear the advice coming out of the Health Department about the need to flatten the infected cases curve due to the possibility of a steeper curve overwhelming the country's healthcare capability, we can immediately see that this is a modified "common pool" problem, which can typically be characterized as a negative externality problem.

In the common pool problem, the commons is available and owned by everyone but it is a depletable resource. Overuse results because use is free, so there is no care taken about how one uses it. Everyone uses it to maximize their benefit, but because the commons is rival, this reduces the amount of it available to everyone else who also own the commons.

The result is inefficient overuse, referred to as the tragedy of the commons.

Can we see the similarity with the coronavirus problem? Our everyday activities which involve social interactions are assumedly "free" and are carried out without care to whatever extent made us happy, just like Damien with his trip and the actions he carried out on his return from the trip. However the incidence of the coronavirus has made the commons of social interactions some sort of "depletable" good. Our interactions now impose a negative externality on others in society by increasing their odds of getting infected and thus reducing their quality of life.

So leaving us to act normally, we deplete the commons very quickly, because we will spread the virus very quickly throughout the population and adversely affect many, some of whom will unfortunately die. As with the commons, one preliminary private solution is to encourage everyone to voluntarily cut back on their use of the commons.

In a typical economics principles class we suggest that this measure might fail because the payoff from defecting may be large: if others are cutting back, one stands to benefit from not cutting back. While this may not be readily applicable in our realistic situation, the fact that some do not heed this advice often then leads to the government having to make it more explicit by imposing forced quarantines, isolations, bans and curfews etc.

The government thus undertakes ownership of the commons and allocates its use in a manner that would prevent inefficient overuse. In this case, to limit social interactions so as to manage the number of critical infections from overwhelming our healthcare capabilities, which leads to higher fatalities than otherwise.

Lessons to Learn

Some are often quick to point to economics as the culprit that leads societies to make wrong choices, for example, any delays in taking steps to mitigate the crisis would have been chalked up to "economic reasons", and this is often the fundamental reason why governments are typically slow to act. They think more about the economic costs of the actions mostly in terms of lost incomes (or revenue flows).

It is however more accurate to say that economics plays its role based on what credible information it has to work with. We understand the importance of externalities and know how to think about solutions to these, but we need the science behind the crisis to let us know what we are up against, then we can provide proper valuations, and suggest recommendations.

With a negative externality, the solution is either a tax equal to marginal social damage to engage in the activity, or a subsidy equal to the marginal private damage associated with not engaging in the activity.

Clearly the disease process behind how the coronavirus works, the speed at which it is spread, and its ability to do this while the carrier is assumedly healthy and showing no symptoms, along with the speed of degeneration in eventually critical and fatal cases, tells us that we have a situation that can very quickly overwhelm our healthcare facilities in terms of being able to care for this and other existing critical illnesses.

The external costs therefore are prohibitively high both from this and the loss of productive activity that necessarily results from infected individuals being unable to work. Importantly, no one person can be pointed at to bear the cost, so the solution has to take on the form of a subsidy to not engage in the externality generating activity.

Mandating that schools close, that restaurants and businesses close, that people not engage in those activities that ordinarily they would have enjoyed and derived pleasure in, imposes a cost to them, so the government by providing several rounds of stimulus to provide income support to them is providing the analogue of a subsidy to help defray those costs.

Of course the exact amount of such a subsidy is what we would like to compute for precision purposes, and this may be well above the $1trillion package being proposed, but what is important for now is that with the expectation of the benefit, people choose to have fewer social interactions, we flatten the curve, we have fewer cases that can be managed by our healthcare facilities, we slow the spread of the virus, and buy our hard working researchers more time to 'renew the commons' - get a drug and eventually a vaccine that works.