DP14596 COVID-19 Infection Externalities: Trading Off Lives vs. Livelihoods

Author(s): Zachary Bethune, Anton Korinek
Publication Date: April 2020
Keyword(s): cost of disease, COVID-19, infection externalities, social distancing
JEL(s): E1, E65, H12, H23, I18
Programme Areas: Public Economics, International Macroeconomics and Finance, Macroeconomics and Growth
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=14596

We analyze the externalities that arise when social and economic interactions transmit infectious diseases such as COVID-19. Individually rational agents do not internalize that they impose infection externalities upon. In an SIR model calibrated to capture the main features of COVID-19 in the US economy, we show that private agents perceive the cost an additional infection to be around $80k whereas the social cost including infection externalities is more than three times higher, around $286k. This misvaluation has stark implications for how society ultimately overcomes the disease: individually rational susceptible agents act cautiously to "flatten the curve" of infections, but the disease is not overcome until herd immunity is acquired, with a slow recovery over several years. By contrast, the socially optimal approach in our model contains and eradicates the disease, producing a much milder recession. Eradication is optimal even if the infected and susceptible cannot be targeted independently, although the economic cost is much higher.