The Economic Effects Of Pandemics: An Austrian Analysis

dollarsTraditionally, Austrian theorists have focused with particular interest on the recurrent cycles of boom and recession that affect our economies and on studying the relationship between these cycles and certain characteristic modifications to the structure of capital-goods stages. Without a doubt, the Austrian theory of economic cycles is one of the most significant and sophisticated analytical contributions of the Austrian School. Its members have managed to explain how credit-expansion processes lead to systematic investment errors that result in an unsustainable productive structure. Such processes are advanced and orchestrated by central banks and implemented by the private banking sector, which operates with a fractional reserve and creates money from nothing in the form of deposits, which it injects into the system via loans to companies and economic agents in the absence of a prior real increase in voluntary saving. The productive structure shifts artificially toward numerous projects which are too capital intensive and could mature only in a more distant future. Unfortunately, economic agents will be unable to complete these projects, because they are not willing to back them by sacrificing enough of their immediate consumption (in other words, by saving). Certain reversion processes inevitably follow and reveal the investment errors committed, along with the need to acknowledge them, abandon unsustainable projects, and restructure the economy by transferring productive factors (capital goods and labor) on a massive scale from where they were used in error to new, less ambitious but truly profitable projects. The recurrence of the cycle can be explained both by the essentially unstable nature of fractional-reserve banking as the main provider of money in the form of credit expansion and by the widespread inflationary bias of theorists, political authorities, economic and social agents, and above all, central bankers, who view economic prosperity as a goal to be pursued in the short term at all costs and see monetary and credit injections as a tool which cannot, under any circumstances, be dispensed with. Therefore, once recovery is well underway, sooner or later the authorities again succumb to old temptations, rationalize policies that have failed again and again, and reinitiate the whole process of expansion, crisis, and recession, and it all begins again.

Austrian economists have proposed the reforms necessary to end recurring cycles (basically, the elimination of central banks, the reprivatization of money – the classic pure gold standard – and making private banking subject to the general principles of private property law – that is, a 100-percent reserve requirement for demand deposits and equivalents). However, Austrians have always stipulated that these reforms would not avert isolated, non-recurring economic crises if, for instance, wars, serious political and social upheaval, natural catastrophes, or pandemics cause a large increase in uncertainty, sudden changes in the demand for money, and, possibly, in the social rate of time preference. In such cases, the productive structure of capital-goods stages might even be permanently altered.

In this paper, we will analyze the extent to which a pandemic like the current one (and similar pandemics have struck a great many times in the history of mankind) can trigger these and other economic effects and the extent to which states’ coercive intervention can mitigate the negative effects of pandemics or, on the contrary, can become counterproductive, aggravate these effects, and make them last longer. First, we will study the possible impact of the pandemic on the economic structure. Second, we will consider the functioning of the spontaneous market order driven by the dynamic efficiency of free and creative entrepreneurship. In this scenario, entrepreneurs devote their attention, in a decentralized manner, to detecting the problems and challenges a pandemic poses. In contrast, we will analyze the impossibility of economic calculation and of the efficient allocation of resources when political attempts are made to impose decisions from above; that is, in a centralized way, using the systematic, coercive power of the state. In the third and final section of this paper, we will examine the specific case of massive intervention by governments and, especially, central banks in monetary and financial markets to deal with the pandemic by seeking to lessen its effects. We will focus also on simultaneous government policies involving taxes and an increase in public spending which are presented as the panacea and universal remedy for the evils that afflict us.

1. The Effects of Pandemics on the Real Productive Structure: The Labor Market, the Process of Capital-Goods Stages, and the Impact of Uncertainty

1.1. The Labor Market

The emergence of a new, highly contagious illness which spreads throughout the world and has a high mortality rate constitutes, without a doubt, a catastrophic scenario capable of producing a number of serious economic consequences in the short, medium, and even long term. Among these is the cost in terms of human lives, many of them still actively productive and creative. Let us recall, for instance, that the so-called “Spanish flu” killed an estimated 40 to 50 million people worldwide beginning in 1918 (over three times the number of dead, including both combatants and civilians, in World War I). This flu pandemic attacked mainly men and women who were relatively young and strong; that is, people of prime working age.1 In contrast, the current Covid-19 pandemic caused by the SARS-CoV-2 virus produces comparatively mild symptoms in 85 percent of those infected, though it hits the remaining 15 percent hard. It requires even hospitalization for one-third of these and leads to the death of close to one in five of those hospitalized with a severe case of the disease, the vast majority of whom are elderly, retired people, and people with serious pre-existing conditions.

Thus, the current pandemic is not having a noticeable impact on the supply of labor and human talent in the labor market, since the increase in deaths among people of working age is relatively small. As I have already mentioned, this situation differs considerably from the one that arose with the “Spanish flu,” after which it is estimated that the aggregate supply of labor fell worldwide by over 2 percent. This figure takes into account fatalities from both the disease and World War I (40 or 50 million casualties from the disease and over 15 million from the war). This relative shortage of labor pushed up real wages during the Roaring Twenties when the restructuring of the world economy was completed. It went from a wartime to a peacetime economy, and the whole process was accompanied by great credit expansion, which we cannot analyze in detail here, but which, at any rate, set the stage for the Great Depression that followed the severe 1929 financial crisis.2

Over the course of history, various pandemics have actually exerted a much stronger impact on the labor market. For instance, it is estimated that the Black Death, which ravaged Europe beginning in 1348, reduced the total population by at least one-third. The acute, unexpected shortage of labor that resulted led to considerable real-wage growth, which took hold in subsequent decades. It is exasperating that monetarists and, particularly, Keynesians tiresomely go on about what they suppose to be the “beneficial” economic effects of wars and pandemics (for everyone except the millions who are killed or impoverished by them, I imagine). It is argued that these tragedies permit economies to overcome their lethargy and start on the road to a buoyant “prosperity.” At the same time, such calamities provide justification for economic policies of intense monetary and fiscal interventionism. With his customary insight, Mises refers to these economic theories and policies as pure “economic destructionism,” since they simply serve to increase the money supply per capita along with, and especially, government spending.3

1.2. The Productive Structure and Capital Goods

Aside from these effects on the population and the labor market, we should also consider the impact a pandemic exerts on the social rate of time preference and hence, on the interest rate and the productive structure of capital-goods stages. Perhaps the most catastrophic scenario conceivable is the one Boccaccio describes in his introduction to the Decameron when he writes of the bubonic plague that afflicted Europe in the fourteenth century. For if the belief becomes widespread that everyone is very likely to catch a disease and die in the short or medium term, it is quite understandable that subjective valuations become geared toward the present and immediate consumption. “Let us eat and drink, for tomorrow we die.” Or conversely, “Let us repent, do penance, pray, and get our spiritual lives in order.” These two opposing and yet perfectly comprehensible attitudes toward the pandemic have the same economic effect: What sense is there in saving and launching investment projects that could mature only in the distant future if neither we nor our children will be here to enjoy the fruits of them? The obvious result could be seen in fourteenth-century Florence, ravaged by the bubonic plague. En masse, people abandoned farms, livestock, fields, and workshops, and, in general, they neglected and consumed capital goods without replacing them.4 This phenomenon can be illustrated graphically in a simplified fashion as described in the section “The Case of an Economy in Regression” of my book Money, Bank Credit, and Economic Cycles.5 There, I use the well-known Hayekian triangle, which represents the productive structure of a society. (For a detailed explanation of its meaning, see pages 291 and following of the book.)


As we see in Chart 1, in this case, a sudden, dramatic increase in the social rate of time preference augments immediate monetary consumption (figure b) at the expense of investment. Specifically, numerous stages (represented by the shadowed area in figure c) in the production process are abandoned, a very large portion of the population stops working (either because of death or voluntarily), and the survivors earnestly devote themselves to consuming consumer goods (the prices of which, in monetary units, skyrocket due to the reduction in their supply and the widespread decrease in the demand for money). Transactions in the time market and loanable funds practically come to a halt, and interest rates on the few that do take place go through the roof.

In contrast to the above scenario, there is no indication that the current Covid-19 pandemic has been accompanied by a significant change in the social rate of time preference (aside from the effect of a temporary increase in uncertainty, which we will discuss later). To begin with, the current circumstances in no way resemble those of a pandemic as virulent as the one Boccaccio describes in the Decameron. As I have pointed out, the expected mortality among people of working age is virtually negligible, and expectations regarding the successful completion of investment processes that will mature in the distant future remain unchanged. (For instance, investments are still being made in the design, innovation, and production of the electric cars of the future and in many other long-term investment projects.) And since the social rate of time preference remains basically unchanged, the productive structure of capital-goods stages described in a simplified manner in our Hayekian chart also remains unchanged, except for three effects – one in the immediate short term, another in the medium term (one to three years), and another in the long term (which may become indefinite).

1. First, there is the immediate, short-term effect (lasting a few months) exerted on the real productive structure by the coercive confinement measures governments have imposed. We can assume that the economic standstill decreed for several months has, in relative terms, affected mainly those productive efforts furthest from final consumption. After all, the population – even people confined to their homes and unable to work – have had to go on demanding and consuming consumer goods and services (even if through e-commerce – Amazon, etc. – since many stores and final distributors were forced to close, because their activities were considered “non-essential”). If this is so, and assuming the final demand for money intended for consumption has not significantly changed, either because households on government-imposed lockdown have dipped into their financial reserves or because they have made up for their decrease in income by relying on temporary unemployment subsidies (lay-off compensation, etc.), the productive structure in monetary terms will have fluctuated over a short interval like a pendulum, as shown below (in Chart 2).


At any rate, when the compulsory “disconnection” from the production process ends and productive factors are again employed, the production process can start again where it left off since no systematic, malinvestment-causing errors requiring restructuring have come to light.6 Unlike what happened in the Great Recession of 2008, the productive structure has not been irreversibly harmed, and thus there is no need for a prolonged, painful process of reorganization and massive reallocation of labor and productive factors: All that is needed is for entrepreneurs, workers, and self-employed people to go back to work, pick up their tasks where they left off, and use the capital equipment that was not damaged (several months ago) and is still available now.

Concerning this first effect in the immediate short term, I should clarify that it would also have appeared – though it would have been much gentler and less traumatic and, thus, would have caused a much smaller fluctuation than the pendular movement reflected in the chart – if confinement had been voluntary and selective and the decision had been made on the “micro” level by families, companies, residential areas, neighborhoods, etc. in the context of a free society in which either no monopolistic governments exist (and instead we have the self-rule of anarcho-capitalism) or they are not centralist and do not impose widespread, coercive, and indiscriminate confinement measures.

2. Second, various sectors fundamentally associated with the stage of final consumption are still experiencing a dramatic decrease in demand after the confinement and may continue to do so for many months7 until the pandemic has ended and activities have completely returned to normal. These sectors deal primarily with tourism, transportation, the hotel industry, and entertainment, and relatively speaking, they are very important to certain economies like that of Spain, where tourism accounts for almost 15 percent of GDP. Such sectors require a more profound change than the mere pendular fluctuation described in the first point above. Instead, circumstances necessitate a change which has an impact on the productive structure for a longer period of time (around two years). Obviously, other things being equal, if households spend less on air transportation, hotels, restaurants, and theater performances, they will spend more on alternative consumer goods and services, or substitutes, they will devote more of their income to investment, or they will increase their cash balances. Aside from a possible increase in the demand for money, which we will discuss later when we consider uncertainty, clearly, the productive structure will have to adapt temporarily to the new circumstances by making the most of the active resources remaining in the sectors (at least partially) affected. I am referring particularly to those resources that are, for a time, involuntarily unemployed and will have to be reallocated to alternative lines of production where they can find fruitful (temporary or definitive) employment.

As an illustration, certain restaurants will stay open against all odds by adapting their offerings (for instance, preparing meals for home delivery), reducing costs as much as possible (laying off personnel or retraining them directly or indirectly – for example, to be delivery people), and adjusting their liabilities to suppliers in order to minimize losses and capital consumption. In this way, the owners avoid having to throw away years invested in building a reputation and accumulating highly valuable capital equipment that is difficult to repurpose. And they hope that, when circumstances change, they will be better positioned than their competitors and have a great competitive advantage when coping with the renewed recovery that is expected for the sector. In contrast, other entrepreneurs will choose to withdraw and “hibernate” by temporarily closing their doors but leaving the corresponding facilities and business contacts prepared for a reopening as soon as circumstances permit. Yet another group of businesspeople – generally those whose entrepreneurial projects were marginally less profitable even under pre-pandemic conditions – will be forced to permanently shut down their businesses and liquidate their respective entrepreneurial projects.

All of these entrepreneurial activities and decisions can and must take place relatively quickly, and costs must be minimized. This will be possible only in a dynamically efficient economy which encourages the free exercise of entrepreneurship and does not obstruct it with harmful regulations (especially in the labor market) and discouraging taxes. Clearly, it will not be the government or public officials who will manage to make the most appropriate decisions at every moment and in each set of specific circumstances of time and place. Instead, it will simply be an army of entrepreneurs who, in spite of all adversity, wish to move forward and, with fortitude and unshakeable trust in a better future, remain confident that sooner or later it will arrive.

Regarding the triangle we use to represent, in a simplified way, the productive structure, the most we can depict (see Chart 3), assuming no significant change in the social rate of time preference occurs, is a horizontal fluctuation of the hypotenuse, first to the left, which shows the overall impact of the decrease in demand experienced in the affected sectors (and by suppliers in those sectors), and then back to the right, as it is replaced by new demand over the period of months it takes for complete normalcy to return, and to the extent that most of the money demand lost in those sectors is recovered.


Obviously, the chart does not permit us to show the countless entrepreneurial decisions and real investment transactions that result in the rapid and flexible horizontal fluctuation represented by the two-way arrows. The chart does, however, permit us to visualize the grave risk involved in launching policies that tend to make the productive structure more rigid by maintaining zombie companies that should be liquidated as soon as possible and by making it more difficult, via regulations and taxes, for a rebound to occur and push the hypotenuse of our triangle back to the right. In fact, fiscal and regulatory intervention can fix the real productive structure in the BB position indefinitely and prevent it from rebounding toward the AA position.

It goes without saying that all of these rapid-adjustment and recovery processes require a highly agile and flexible labor market in which it is possible to lay off and rehire personnel very quickly and at a minimal cost. We must remember that unlike what happened in the Great Recession of 2008 (and happens in general after any financial crisis that follows a lengthy process of credit expansion), in the current pandemic we are not starting from a widespread malinvestment of productive factors (in the building sector, for instance, as occurred in 2008) which could justify a large volume of long-term structural unemployment. Instead, it is possible now to reallocate labor and productive factors in a quick, sustainable, and permanent way, but the corresponding labor and factor markets must be as free and agile as possible.

3. Third, we have yet to analyze the possibility that certain changes in the consumption habits of the population may occur, become permanent, and require permanent modifications to society’s productive structure of stages of investment in capital goods. We should point out that in any uncontrolled market economy, the productive structure is always adapting in a gradual, non-traumatic way to changes in consumers’ tastes and needs. It is true that the pandemic may hasten most consumers’ discovery and definitive adoption of certain new behavioral habits (pertaining, for instance, to widespread participation in e-commerce, the increased use of certain payment methods, and the mainstreaming of video conferences in the world of business and education, etc.). However, in practice, we may be exaggerating the impact of these supposedly radical changes, especially if we compare them to the changes that have arisen, since the start of the twenty-first century, both from an even greater globalization of trade and exchange and from the technological revolution that has accompanied it and made it possible. These developments have enabled hundreds of millions of people to escape from poverty; billions of people (particularly from Asia and Africa) who until now remained outside the circuits of production and trade distinctive of market economies have been incorporated into the flows of production. Thus, the productive forces of capitalism have been unleashed like never before in the history of mankind. And despite the burden of state intervention and regulation, which continually hinder progress and clip its wings, humanity has achieved the great social and economic success of being 8 billion strong and maintaining a standard of living that only a few decades ago could not even have been imagined.8 From this perspective, we should justly give less importance to the long-term impact of the current pandemic in a context of much bigger and more profound changes to which market economies are constantly adapting without major difficulties. Hence, we should again turn our analysis to the study of the short- and medium-term effects of the current pandemic, since, due to their closer proximity to us, we can regard them as more significant at this time.

1.3 Uncertainty and the Demand for Money

To wrap up the first part of this paper, we will now consider the impact of the uncertainty the pandemic has caused. In taking this approach, my main purpose is to highlight, as we will see in the final part, the fact that this uncertainty has led to even further promotion of fiscal and (especially) monetary intervention policies so extremely lax that they are historically unprecedented, pose a serious threat, and may well continue to have severe consequences once the current pandemic has ended.

Initially, the impact of a pandemic on uncertainty and, thus, on the demand for money can range between two opposing extremes. A pandemic may be so virulent that, as we saw in the case of the bubonic plague in Florence in the mid-fourteenth century, which Boccaccio describes so well in the Decameron, more than uncertainty, it gives a very large swathe of the population the certainty that their days are numbered and that hence, their life expectancy has been drastically reduced. Under such circumstances, it is understandable that the demand for money collapses and money loses much of its purchasing power in a context in which no one wishes to part with goods or provide services whose production has largely nosedived, and most people wish to consume these as soon as possible.

1 2 3 4
View single page >> |

Mises Institute is a tax-exempt 501(c)(3) nonprofit organization. Contributions are tax-deductible to the full extent the law allows. Tax ID# 52-1263436

How did you like this article? Let us know so we can better customize your reading experience.


Leave a comment to automatically be entered into our contest to win a free Echo Show.