|Date||July 30, 2020|
|Speaker||Robert S. PINDYCK (Bank of Tokyo-Mitsubishi Professor of Economics and Finance, Sloan School of Management, Massachusetts Institute of Technology)|
|Commentator||YANO Makoto (Chairman, RIETI)|
|Moderator||SABURI Masataka (Director, PR Strategy, RIETI)|
Robert S. PINDYCK: I wrote an article for the Institute last year in which I said that we face numerous global catastrophic risks; much of my work in the last several years has been related to catastrophic risk. One of these is a major pandemic as bad as or even worse than the 1918-1919 Spanish Flu.
Should we be surprised about this? Three years ago, the Centers for Disease Control and Prevention (CDC) in the US, wrote, quote, "The threat of a ‘mega-virus’ that could cause widespread fatalities is considerable. While we can't predict exactly when or where the next pandemic will begin, we know one is coming. The reasons: increased risk of infectious pathogens spilling over from animals to humans; development of antimicrobial resistance; spread of infectious diseases through global travel and trade; acts of bioterrorism; and weak public health infrastructures."
What have we learned from this and what should we do? I've been writing for several years now that we face numerous potential global catastrophes: pandemics, nuclear terrorism, bioterrorism, a climate catastrophe, a global financial collapse, a major earthquake. Most people don't like to think about these things, but I think we need to both think and talk about them. We have to prepare rather than just waiting for things to happen. This raises the following question: what fraction of GDP should be devoted to reducing our vulnerability to these risks? Preparation is expensive. How much should we spend? The answer depends in part on the value we place on the loss of human life, because some of these catastrophes kill people. We need to think about how bad it is if hundreds of thousands of people die.
Risk reduction policies
The standard framework we economists use is cost-benefit analysis. What is the benefit of preventing a potential catastrophe or reducing its likelihood? We usually look at that in terms of "Willingness to Pay" (WTP). This is society's reservation price: the maximum amount society is willing to give up in order to prevent a catastrophe. The reservation price is an economic concept. For example, in the morning I need coffee. My reservation price for the first cup of coffee in the morning is very high, $20, alright? I don't have to spend $20. Normally, I can buy a cup of coffee for $2 or $3. However, my reservation price—the most I'd pay—is much higher. That's what we're looking at here: what's the most we would pay? That's the idea of the benefit of reducing the likelihood or averting a catastrophe. We usually express WTP as an annual percentage of GDP that society is willing to sacrifice.
We can look at the cost in the same way. What is the annual percentage tax on consumption or GDP we would have to pay in order to avoid this catastrophe? If the tax does not exceed WTP, this is a good deal: the benefit is greater than the cost, so we should do it. If the tax exceeds WTP, we do nothing to prevent the catastrophe. This is the standard way economists model this. This is not a simple thing to do. How do you determine the cost of preventing nuclear terrorism, for example? How do you determine WTP for that? It's very difficult.
The fact that these are not small, marginal projects further complicates matters. Preventing pandemics, nuclear terrorism or a climate catastrophe takes major effort. This is not like building a bridge or building a highway. The underlying assumption of standard cost-benefit analysis is that the project is marginal; it doesn't affect the overall economy. That's not the case here. A project to prevent nuclear terrorism or climate change is going to reduce GDP while raising the marginal utility of consumption. The result is that we may not want to avert a catastrophe even if the benefit is greater than the cost. Which one should we avert? Suppose that society faces seven big potential catastrophes. Suppose it is feasible to avert all seven. Should we? The answer is: not necessarily. Which ones should we avert? Well, this is the problem that I looked at nearly five years ago in a paper I co-authored called, "Averting Catastrophes: The Strange Economics of Scylla and Charybdis."
Choosing which catastrophes to avert
The paper uses eta as a social index of society's overall risk aversion. We graphed eta values of 2 and 4 because macroeconomic and financial data suggest that this coefficient is somewhere in the range of 2 to 4, or 5. WTP is the vertical axis while the horizontal axis is the required tax. The blue line at a 45-degree angle is where the benefit equals the cost. Anything above the line, the benefit exceeds the cost. A dot means you should avert it while a plus-sign means you shouldn't. A nuclear catastrophe is a blue dot, which means we should avert it. The left graph, with the coefficient at 2, indicates that of the seven catastrophes, we should give up on earthquakes and climate. Where risk aversion is higher in the right graph, we should prevent the climate catastrophe while not worrying about earthquakes, storms or bioterrorism. The catastrophe with the highest benefit-cost ratio is a mega-virus pandemic, indicating that pandemics should certainly be averted.
As for the current pandemic, there is not going to be a vaccine within the next 12 months. The earliest we would have the results of the first clinical trials would be somewhere around January. What we can do is social distancing, lockdowns and school and business closures. How strict should these measures be and for how long should they be used? We face a cost-benefit problem. The cost of lockdowns and social distancing is mostly economic--unemployment and lost GDP, while the benefit is lives saved.
Placing a monetary value on human life
How do you decide how much lives are worth? We typically use estimates of what's called the value of a statistical life (VSL) to value each life. In the US, the VSL the government uses is about $10 million per person. If you use that number, you're going to find that the benefit of strict lockdowns is much greater than the cost for most countries because you are saving very valuable lives. However, is $10 million the right number? Maybe it's not. Another problem with the cost-benefit analysis is the following. Suppose you want very strict social distancing, you want to dramatically reduce the contagion rate, you don't want people interacting, you say we have to immediately lock everybody up, so nobody goes out, and everyone has to cover their whole head, or any other extreme measures. That will unquestionably save lives but it will also lengthen the duration of the pandemic.
From a recent paper I wrote, using a simple susceptible-infected-recovered (SIR) model with one extra variable called "dead," with a 2% death rate which may be too high, we see the dynamics of the infection within a lockdown, measured in days, for different degrees or levels of contagion (R0), from 1.5 to 3.0. In a strict lockdown, which reduces your infection rate (R0), the good news is that fewer people die in the end, but the bad news is that in the end, there are still a lot of susceptible people which means there could be a second wave, and the other bad news is that the infection lasts a lot longer. If every day we are losing GDP because of the lockdowns, we are going to be losing a lot of GDP.
In this next graph, the horizontal axis is the degree of contagion where 1 means there is no contagion and the pandemic will basically disappear, and 3 means that everyone interacts with everyone without masks and the pandemic continues to escalate. At lower values of contagion, small increases dramatically change the number of deaths. In other words, if you lower the contagion from 1.5 down to 1.2, you will get a very significant reduction in deaths. However, if you're already at 2.5 and you raise it to 3, it's not going to make such a large difference. There will be some increase in deaths but not a big one. This is a complicated problem. First, very strict lockdowns will prolong the pandemic. Second, whether the lockdown is mild or strict will not be effective enough to bring the R0 number below that critical number to save many lives. Really saving lives requires a very strict social distancing policy, which will actually bring the death rate down.
The value of life is fundamental to thinking about things like pandemics. Suppose your probability of dying this year is 2%. We offer you a job that raises your chance of death to 2.5% but that also will pay 50% more than you now earn. Should you take that job? Would you take that job? The answers depend on how you value a 2% versus 2.5% chance of death. We look at data on millions of decisions of this kind and we use this to estimate the VSL. Current estimates range from $2 million or $3 million to $15 million per person. The regulatory agencies in the US generally use a number around $10 million, but there are problems with this. First, VSL is based on small increases in the chance of death, starting from a small number, not a big increase. Is this correct given that we are looking at bigger numbers?
Second, VSL increases with wealth. Wealthier people are willing to pay more to reduce their chance of death. Should we therefore give greater value to their lives? Third, the VSL does not aggregate. If we think that the correct number for the US is $10 million, and we look at the whole country, 330 million people, what do we get? We get $3,300 trillion; about 150 times US GDP. We don't have that money and we're not going to have it for the next 30, 50 or 100 years. What does it mean to say that these lives are worth $10 million each? People may say that in their own minds they are willing to give up $10 million for their lives if we ask them what they are willing to pay to avoid death, but there isn't that much wealth around. My view is that this number is probably too high and for pandemics we should use a smaller number. Maybe in the US it would be $1 million or $2 million.
What value should society as a whole place on human lives?
The VSL is about how people value their own lives and risk of death, but we don't know how society should value increases or decreases in population. In a soon-to-be-published paper I am co-authoring with Ian Martin, we look at two potential catastrophes: a major pandemic and a serious economic recession or depression. We calculate the WTP to avert each one. The financial collapse will be a consumption catastrophe and the pandemic a death catastrophe. What is the willingness to pay to avert both? WTP is higher for the consumption type because consumption catastrophes are very harmful and frequent. If there were no death catastrophe but only a consumption catastrophe, the number would be lower. In other words, the presence of a pandemic raises the WTP to avert a consumption catastrophe, and vice versa. We supposed that the correct VSL is less than $10 million. At $2 million or $3 million, the WTP to prevent pandemics approaches 3% of GDP.
We actually spend almost nothing in the US annually to prevent pandemics. We are spending almost nothing this year on manufacturing masks, investing in vaccines and drugs, financing the growth of the CDC and so on. In fact, the Trump administration wants to cut the CDC's budget and we have left the WHO. The US is not paying its dues to the WHO. The WTP for any value of the VSL is much higher than what we actually spend.
We don't know how to value changes in population. Some say that increases in population are good: we need them for growth and we need young people to support the elderly. Some say population growth is bad because it increases overcrowding, congestion and the burden on the environment. No one agrees. We seem to think that decreases in population are bad based on social policy, because we try to save lives and we try to prevent the loss of life, in anything from traffic accidents to disasters, but how do you value these increases or decreases in population? This is an open question in economics today.
First, let's say we have a vaccine a year and a half from now. We don't know how long immunity will last or how effective it will be. Every virus mutates. Smallpox, for example, evolved from a very large genome over the centuries to a smaller genome with a much higher death rate. We don't know how COVID will evolve and mutate. We're back to the pre-COVID problem: we'll have to spend much more preparing for the next pandemic, because it might be a variety of COVID. In addition to pandemics, we face other catastrophes we have to spend money to avert: bioterrorism, climate change, etc.
First, we should not have been so surprised by the COVID pandemic. The CDC, the WHO and many others have been warning that a major pandemic was just a matter of time. The risk of other catastrophic threats has always been clear, but governments are unwilling to do much. We have to figure out how to value human lives and recognize that while strict social distancing reduces the infection rate, it lengthens the time horizon. Hopefully we will eventually have an effective vaccine. In some sense, even after COVID, we are back where we started because we have to plan for new mutations. We have to spend much more preparing for the next pandemic. We also have to face the fact that we face multiple potential catastrophes, and we have to spend more to prevent them or reduce the likelihood of their occurring.
YANO Makoto: One important and unfortunate thing about this crisis is its timing: the world was already in a fragile political state when it occurred. What do we do about that? The political factors seem to be very important, and I would like to hear your opinion about them.
In many cases, political leaders have made mistakes and bad decisions and misinformed the public, making the situation far worse. Scientists seem to agree that the mask is the simplest and most effective way of fighting the pandemic, which has been our experience in Japan. On the other hand, Dr. Fauci in February said there was no reason for anyone in the US to wear a mask, and they were very afraid that the medical profession would lose access to masks. They tried to suppress people's use of masks. This was a huge mistake in retrospect and I don't know how it could have been avoided. People have been beaten up or killed over the wearing of masks. Strong anti-mask sentiment exists in some segments of the populace. These things too will form the course of the pandemic.
You emphasized preparation for possible disasters, and I would like to know more about the political factors. I wrote a paper recently in which I argue that self-protection by individuals really seems to be the key in this kind of pandemic: wearing masks and being cautious. I would like to know your thoughts on these factors and any other factors you might think are crucial in this ongoing disaster.
Robert S. PINDYCK: The situation in the US is very sad. There is no real leadership or rational, coherent policy. The US right now is an extremely polarized country. The result is that people view wearing a mask as a political statement. What do you do in an ongoing disaster? You don't do what the US is doing. The states have been left to fend for themselves, and some are doing well while many are not. You need to have leadership. Why can't we spend the money to prevent these things? Why can't we do a better job of overcoming the pandemic? We don't have leadership.
People were surprised by this crisis because they like to think that nothing important is going to change. We know we might get sick, there can be accidents, but basically it's very hard for people to think about major upheavals that could completely change their lives. For the same reason, it’s hard for governments to say we have to spend lots of money now to prevent things that might happen in 20 or 30 years.
YANO Makoto: Many observers say that even if a vaccine is developed, it will be very hard for the government and others to convince certain people to get it, and that this will prolong this American economic downturn. How would you cope with this problem?
Robert S. PINDYCK: I think you can compel people to take the vaccine by doing things we already do in the case of other infectious diseases for which we have vaccines, like measles: saying unvaccinated children can’t go to school, for example. I think we have been very successful. I have a different concern, which is the number of poor people without health insurance in the US. How do they get vaccinated? I am more concerned that even if everyone wants the vaccine, they may not have access to it. The healthcare system in the US is very complicated and is not a great system. Some people have no access to healthcare and some people don’t have the money. I’m worried about that.
YANO Makoto: I feel that unless a nation has the right leader, it is hard for it to deal with a potentially disastrous event. My question is what can you do if the wrong leader is in power when a disaster happens? If you are a militarist regime you can have a coup d'état but that’s unacceptable in a democratic society. Is there any sensible approach to this problem? Americans tried impeachment but that didn’t work out.
Robert S. PINDYCK: I am pessimistic. Here in the US, we are going to have an election in three months. I am obviously hoping that Trump is not re-elected. We don’t have the right leadership now. But what do you do? If you look at the histories of countries and civilizations, why did the Roman republic disintegrate? Bad leadership. When you have the wrong leaders, bad things happen. I’ve talked about catastrophes that are outside the political spectrum, but what about nuclear war? Can you look at the countries that have nuclear weapons and assume that we can rely on them to make rational decisions? We live in a world with a lot of dangers and risks. In terms of COVID, Trump is limited in the amount of damage he can do. The US could have dealt with it better but we will come out of it okay in the end. I hope this talk has not been too depressing. I wish I had something more cheery to say.
*This summary was compiled by RIETI Editorial staff.