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When imposing a pandemic lockdown, promises matter

Why society benefits when governments make well-informed commitments to lift business lockdowns—and stick to them

November 4, 2021

Author

Jeff Horwich Senior Economics Writer
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Jake MacDonald/Minneapolis Fed

Article Highlights

  • Officials with complete flexibility to extend lockdowns will ignore essential information
  • Businesses will underinvest, anticipating their investments will be disregarded
  • Commitment can still give government ability to adapt to an evolving pandemic
When imposing a pandemic lockdown, promises matter

In March 2020, President Donald Trump and Anthony Fauci stepped to the White House podium to ask Americans for 15 days to slow the spread. It was the first of many less-than-durable pandemic promises.

As the waves of COVID-19 rose and fell, elected and public health officials frequently changed their messages and restrictions on economic activity. Some governors who initially resisted lockdown measures reversed course. Others renewed open-ended lockdowns that became entangled in state politics: In the Minneapolis Fed’s Ninth District, Minnesota’s governor extended his emergency declaration 14 times, before lifting it as part of a deal to secure Senate passage of a state budget. In Wisconsin, the state Supreme Court ultimately refereed bitter disputes between the governor and the Legislature.

As the New York Times put it, we had “a nationwide patchwork of rules for businesses and residents result[ing] over months of trial and error, as governors reopened some sectors only to later re-close and reopen them again.” County and city mandates added to the shifting landscape.

Amid this policy chaos, economist Christian Moser—like many of us—was ordering takeout.

A pizza shop confronts the unknown

“My local pizza shop told me their workers weren’t showing up,” says Moser, a senior research economist for the Minneapolis Fed and assistant professor at Columbia Business School. “They were wondering what they should do. Close down? Stop paying rent?”

The uncertainty forced businesses of all sizes to roll the dice about when and how officials would lift lockdowns. “If I’m the pizza shop owner and I expect that at some future date things will be back to normal-ish again, I have to prepare for that,” Moser says. “Renew my lease. Stock up on ingredients. Keep my advertising online or in the newspaper.”

To serve customers and stay in business a month or a year from now, companies need to make investments today. But Moser recognized a problem: The government doesn’t necessarily care.

At the moment when officials are analyzing whether to keep, modify, or end a lockdown, any past expenses by our pizza shop are “sunk costs.” When weighing the health and economic implications of a lockdown decision, those prior business expenses are already in the rearview mirror. In the fiscal or policy analysis, sunk costs don’t matter.1

When the incentives of government and the private sector are misaligned at the time of policymaking, economists call this “time inconsistency.” It makes society worse off.

These sunk costs spawn another issue: Well-informed business owners would predict that policymakers will ignore these earlier investments, maintaining a more severe lockdown. Anticipating that their investments might go to waste—and amid great uncertainty about the future—businesses will tend to rationally underinvest.

The result is a longer, harsher lockdown and lower business investment than would have been the case if everyone was considering the same information, at the same time. When the incentives of government and the private sector are misaligned at the time of policymaking, economists call this “time inconsistency.” It makes society worse off.

However, there is a potential remedy: government commitment.

Tying our hands for the greater good

In a recent Minneapolis Fed staff report, Moser and Pierre Yared, also of Columbia Business School, model this disconnect between government and the business world. Their model features the usual beehive of economic activity: Workers supply labor, businesses invest in capital, and government decides on an optimal policy. Into the midst of this humming economy, Moser and Yared drop a COVID-19-style pandemic.

Simulations with and without government commitment

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Note: Using disease-spread data from the initial wave of COVID-19 in the United States, researchers simulated the lockdown, economic, and health outcomes for a government that commits to incorporating prior business decisions versus one that does not.
Source: “Pandemic Lockdown: The Role of Government Commitment,” Staff Report 627, Federal Reserve Bank of Minneapolis

Nestled inside their economic model, the disease spreads under a common epidemiological framework known by the acronym SIRD (susceptible, infected, recovered, and deceased). The pandemic spreads and makes workers less productive. A vaccine is on the horizon, but the timeline may be uncertain. Lockdowns imposed by the government can bolster health outcomes, but they harm the economy by depressing consumption and removing workers from their posts.

Keeping workers at home during a lockdown has a knock-on effect of making past investments less productive—an important consideration for business in deciding how much to invest in capital and intermediate inputs as a pandemic takes hold.

Using COVID-19 data from the early days of the pandemic, the authors simulate two scenarios. In one, the government has complete flexibility to extend its lockdown, based upon the facts on the ground at the time. In the second scenario, the government makes a firm commitment up front: It must take those “sunk” investment decisions by business into account in determining how strict of a lockdown to maintain.

The three charts here illustrate the essential results. The government with commitment imposes a less severe lockdown (Chart 1). Economic activity, as measured by consumption, remains stronger throughout (Chart 2). The share of infected people, however, is higher (Chart 3), as are deaths. Conditions revert to normal after a vaccine arrives (the solid vertical line in each chart).2

An optimal policy will balance preventing infections—and saving lives—with the benefits of keeping the economy running. The government with complete flexibility hurts the economy more than is necessary.

Commitment is always better (when done right)

These outcomes match up with intuition. What might be more surprising is the following conclusion, established in the mathematical proofs of the paper: When weighing public health and human lives against these economic outcomes, society will always be better off if officials commit to a plan ahead of time, even if the path of the virus is hard to predict. The reason is that a commitment to a contingent plan can be valuable, even as we continue to learn about the epidemiological and economic ramifications of a pandemic.

An optimal policy will balance preventing infections—and saving lives—with the benefits of keeping the economy running. The government with complete flexibility hurts the economy more than is necessary.

A few conditions help this conclusion come into focus. First, the model presumes that government officials make decisions that maximize the public welfare, informed by the best available scientific and economic data. A lockdown policy largely driven by misinformation or political ping-pong falls outside this model.

Second, government commitment is not an all-or-nothing proposition. It can include flexibility to respond to evolving conditions. Even as new information about virus cases and hospital utilization comes in, policy decisions are most effective when incorporating the earlier decisions of businesses—along with the latest health data—and providing clear guidance that businesses can rely on for their investments.

Finally, this conclusion does not say that a lighter lockdown is necessarily better. When pandemic conditions are severe and the health and economic consequences of infections are disruptive, imposing or extending lockdowns can be the best policy response. However, even then we will have a better outcome when policymakers lay out a plan that businesses can rely on.

“We can be better off in both economic and health terms if we make smarter policy,” Moser says.

Government commitment in action

While governments do not always behave like our economic models would predict, the COVID-19 pandemic offers examples of what commitment can look like in practice.

In New York state, former Gov. Andrew Cuomo announced a lockdown in March 2020 known as “New York State on Pause.” However, less than two months later, he unveiled seven specific metrics to guide the reopening of the economy. This guidance has proved durable, evolving into the New York Forward program.

To solve the problem of time inconsistency, commitments must be trustworthy. “If you break commitments and do so repeatedly, the policy you try to enact will be void of any content.”

Commitment took a different form in Florida. In September 2020, Gov. Ron DeSantis issued an order preempting local governments from restricting restaurant capacity below 50 percent. Placing this sort of “upper bound” on a lockdown can help assure businesses that their investments will not go to waste.3

To solve the problem of time inconsistency, commitments must be trustworthy. “If you break commitments and do so repeatedly,” Moser says, “the policy you try to enact will be void of any content.” In Florida, DeSantis’ political base and past actions suggested that he would likely remain firmly committed to his promise. In New York, the guidance was data-driven, delivered early in the pandemic, and accompanied by gubernatorial Q&As that were (at the time) widely lauded for their regularity and frankness.

The paper from Moser and Yared makes a timely contribution to decades of fundamental research on government commitment by economists at the Minneapolis Fed and University of Minnesota. They also join the many economists working to learn from this pandemic and prepare for the next one. This includes COVID-inspired research at the Minneapolis Fed to develop smarter approaches to locking down the economy, improve disease models to better capture human behavior, and strike the best balance between sustaining the economy and preventing deaths.


Endnotes

1 The irrelevance of sunk costs is a fundamental principle of economics, but perhaps not the most intuitive. Behavioral economists have explored how the “sunk cost fallacy” still influences personal and microeconomic decisions. Classic examples include wearing a too-tight pair of jeans because of the money you spent on them or continuing to build the supersonic Concorde jet despite the mounting signs that it will be a financial failure.

2 While it does not affect the overall conclusions, the timing and effectiveness of vaccines is one area where recent real-world experience has the potential to inform future models. Rather than a vaccine stopping the virus in its tracks, a significant portion of Americans have declined the shots, and breakthrough infections still affect some vaccinated people.

3 While Moser and Yared provide contemporary examples as context for their research, they do not imply an endorsement of these or other specific lockdown policies.

 

Jeff Horwich
Senior Economics Writer
Jeff Horwich is the senior economics writer for the Minneapolis Fed. He has been an economic journalist with public radio, commissioned examiner for the Consumer Financial Protection Bureau, and director of policy and communications for the Minneapolis Public Housing Authority. He received his master’s degree in applied economics from the University of Minnesota.