Producers may contribute to the economic contagion from COVID-19

Rose Jacobs | May 07, 2020

Sections Economics Marketing

Even if some US states and regions are spared the catastrophic COVID-19 infection and death rates of New York and Detroit, the disease’s economic impact is likely to spread across regions, suggests research from Columbia’s Jay Hyun and Johns Hopkins’s Ryan Kim.

This observation stems from the researchers’ study of how economic shocks spread during the Great Recession, namely through companies operating in multiple areas. 

Knowing that changes in housing values may affect consumer spending, Hyun and Kim looked at how a cooling real-estate market in one area changed the prices and quantities of products producers sold in that market and elsewhere. 

Using housing-price data from Zillow, barcode-level shopping data from the Nielsen Datasets at Chicago Booth’s Kilts Center for Marketing, and manufacturing-level data from the National Establishment Time Series database, they find that economic shocks in one county hurt demand in that same county—but also changed what companies sold elsewhere. Steep slowdowns in one region’s housing-price growth led producers to offer lower-price, lower-quality products even in regions that weren’t as hard hit.

This is in part, they write, because of the scale effect: when demand drops for a more expensive product, a company might no longer have the scale it needs to cover its costs to produce it widely.

“Producers coordinate their product-replacement decision across many markets, which means households in many regions face the same product quality,” Hyun says. “The poor guy in a poor region and the rich guy in a rich region will eat the same cheap, processed, nonorganic cheeses, even if the rich guy in the rich region could have afforded organic cheeses—because organic cheeses won’t be on the shelf.”

How much the economic pain spreads depends in part on the number of areas affected, the study finds. Hyun and Kim’s model suggests that when half the US experiences a shock where, say, consumption falls by 10 percent, the other half sees a 1 percent decline purely because of spillover within companies operating in multiple regions―a 10 percent pass-through. 

In the case of the Great Recession, corporate spillover effects were equivalent to “putting a tax of $400 on people in less-shocked regions and sending out $400 checks to people in more affected regions,” Hyun and Kim write.

The research undermines the idea that companies might respond to asymmetric pain by increasing the availability of higher-quality products in lesser-hit areas. Hyun and Kim argue that slowing house-price gains held back corporate sales growth because of how the shocks affected decisions at the top of a corporation, less so because they hit local demand. 

Moreover, when companies make coordinated decisions across many markets, regions less affected by an economic shock can feel the brunt of the pain. If a county experiences a 10 percentage point decline in housing-price growth, a company’s sales growth decreases in that county by 0.6 of a percentage point—but the sales growth decreases by 3.5 percentage points if other counties where the company operates similarly experience a 10 percentage point decline in housing-price growth. 

While the research predates the COVID-19 virus, some retailers are making moves in line with Hyun and Kim’s findings. Ikea closed all its US stores in March, even though many locations were far removed from any virus hotspot. Concern for employee and customer safety may have played a role in Ikea’s decision, Kim says, but reducing the cost base must also have been a consideration. “Their distribution center might be too big to only supply Kansas City or Utah,” he says.

As long as companies make coordinated decisions across many markets, the effects the researchers identified are likely to persist, the analysis suggests.