Distant islands have advantages in battling COVID-19

COVID-19 has delivered an unprecedented shock to the global and local economies. Policymakers are facing the toughest choices of any time in the post-war period.

To stop the spread of the virus means delivering a costly economic downturn. Not suppressing the outbreak fast enough overwhelms healthcare systems.

Experience elsewhere offers some lessons for Australia and New Zealand.

China adopted aggressive containment measures early, leading to a sharp drop in cases early, and is reopening its economy. Other places like Italy have not been so fortunate. Rising infection rates driven by international visitors are presenting new problems for some locations, like Hong Kong and Singapore.

Over recent days, more countries have moved towards lockdown policies that seek to suppress the spread of the virus.

Being distant island economies offers Australia and New Zealand benefits and costs in the battle against the COVID-19 shock.

An advantage of being islands is that it should be feasible to stamp out the virus in the local population, using suppression measures, and be assured that it will not return – using strict controls on borders. This is the approach that New Zealand has taken. It took only 27 days between the first identified case of COVID-19 in New Zealand and the full lockdown of all but the essential services.

Australian containment policy has been moving in the same direction, but more slowly.

However, suppression clearly sharply weakens economic activity. Hardest hit will be consumption of services, like dining out or attending a live sporting match, as well as service exports. In Australia, the consumption of recreation and hospitality services plus services exports add to around 14% of GDP. The numbers are similar in New Zealand.

Job losses in these industries, which have large casual workforces, are expected to be significant.

Commodity exports, such as iron ore, coal, and rural products, are expected to hold up better. Keep in mind that commodities account for around 65% of Australia’s exports and 45% of New Zealand’s.

To support their economies, policymakers in the two countries have adopted a ‘whole of government’ approach that uses wide economic stimulus measures designed to 'build a bridge' from the pre-COVID-19 world to the post-containment world.

Both central banks have cut their cash rates to the near-zero-lower bound and launched QE programmes to lower interest rates across the yield curve. They have also set up term funding facilities that allows banks to support businesses.

And both have embarked on large fiscal spending packages and more is expected to come.

For Australia, the fiscal spending package has amounted to 9.8% of GDP, with the key focus on businesses and encouraging them to keep their employees. If all of the direct government lending facilities, as well as the RBA’s term facility were used the total would be around 16.5% of GDP.

In New Zealand, fiscal spending of 5.2% of GDP has been announced, with a key focus on directly supporting workers by paying them a wage for the next three months.

The working assumption for policymakers, at this stage, is that the virus will be contained at some point in the next couple of quarters and that then the economy will be able to bounce back.

This is a good starting point and clearly a great hope.

Given New Zealand’s rapid response, we see this as more likely to occur earlier in that country.

But there are also a number of risks to this view that fairly rapid containment will be achieved.

First, it could be that unless a vaccine is developed, suppression measures may need to be adopted for a longer period than expected – locally and/or globally. What might be hoped to be a V-shaped recovery, may turn out to be L-shaped.

In this case, being islands may have an advantage – once the virus is contained, strictly controlling entrants into the country could prevent a further rise in infection rates. But industries that rely on international visitors, such as tourism and education exports, would face significant persistent challenges. Inward migration, which has been a key support for growth in both countries, could be affected.

Second, it could be that the COVID-19 outbreak delivers a permanent change to the economy.

This could be behavioural change that leads to a structural change in the economy, as, for example, there may be less appetite for international travel. It could be that a shift to working from home for many workers changes work patterns permanently, and therefore demand for office buildings or transport infrastructure.

Third, a permanent change could arrive if the economic shock leads to a financial shock that leaves the economy structurally weakened. Given high levels of household debt in both Australia and New Zealand, absorbing the economic shock without it causing a financial crisis will be a top priority for the central bank’s and fiscal policymakers.

These risks are also important for policymakers, businesses and households to keep in mind as they make plans for future investment and where the greatest level of forbearance ought to be provided.