In 2019, UC Riverside economist Gloria González-Rivera and colleagues at Universidad Carlos III of Madrid, Spain, published a research article that estimated a risk of about 30% decline in the gross domestic product, or GDP, of world economies in the event of a worldwide shock. Though the economists did not predict the COVID-19 pandemic, the U.S. Bureau of Economic Analysis recently reported a drop in GDP for the 2020 second quarter at an annual rate of 32.9%, on target with the risk their models predicted.
“We wanted to know: if we were to have a worldwide shock, a rare event, one of those that happens every 100 years or so, what would be the decline in GDP of world economies,” González-Rivera said. “In other words, what is the risk or the potential loss in economic activity that we are facing now?”
This is a question risk managers ask every day when assessing an investment portfolio’s health. The researchers’ question was similar, but at the macroeconomic level. The results predict a scenario that policy makers should prepare for so that corrective measures can be implemented.
González-Rivera and co-authors Javier Maldonado and Esther Ruiz developed a model based on González-Rivera’s previous theoretical research and a data set that included the annual GDPs of 87 countries from 1985 to 2015. They produced a new global risk index called Growth-in-Stress, or GiS. Later, they updated their model using data available through 2018 and found that in 2019, if a global shock were to occur, the world could expect an annual decline of 30% in GDP of industrialized countries, of 34% in emerging economies, and of 27% in other developing countries.
By mid-2020, the COVID-19 pandemic had made their predictions come true.
“The reality of 2020 hits us in the face and I have never been so prescient in my academic research as with this line of work,” González-Rivera said. “We knew we would see what we are seeing now, but models are just descriptions of the world, and we were surprised ours worked so well. COVID-19 is the rare worldwide shock playing havoc in every country in the world.”
Ideally, risk modeling helps policy makers buffer economies against rapid swings caused by unforeseen events. They can use economic forecasting to make better plans for the future, but this needs to be done before the global crisis. Though Congress reacted quickly to cushion the blow, the damage has been done.
“Is the U.S. resilient? It has been proven now that we are not. From April to June 2020, about one-tenth of our GDP has disappeared. These are unprecedented figures,” she said. “The question now is, what can we do to stop the pain?”
González-Rivera said the $600 per week unemployed people were receiving was one of the lifelines that kept America running.
“Congress needs to extend the stimulus. Helping people helps stop the cascade of events that will lead to a further drop in GDP,” she said. “Now that the unemployment insurance has been reduced to $300 a week, it is likely that we will have lower consumption than in Q2, which in turn may affect negatively employment and GDP in the coming quarters.”