The Option-Preserving Value of Social Distancing

The following post is by Ian Ayres, Yair Listokin and Robert Schonberger. Ayres and Listokin are professors at Yale Law School and Schonberger is an associate professor at the Yale School of Medicine.

Critics of measures to mitigate Covid-19, including until Sunday President Trump, argue that the benefits of a long period of social distancing fall short of the economic costs. Others insist that the health benefits exceed the costs, and point to cost-benefit analyses supporting this conclusion. Complicating this debate are the wide range of estimates of case-fatality that have ranged from .01% to 4%, making it nearly impossible to conduct a definitive cost-benefit analysis. Perhaps the one thing that remains abundantly clear is that both the economic costs and the health benefits of extreme social distancing are enormous.

We think that the debate regarding extreme social distancing has a clear verdict — it is imperative that we should engage in this social distancing (shelter in place for all but essential workers) at least for the foreseeable short-term, but for reasons that both sides have missed.

Our country does not need to decide today whether it is worth shutting down the economy for a prolonged period to protect against coronavirus. Instead, we only need to decide what to do for now. And for now, the health benefits of extreme social distancing clearly exceed the costs to the economy regardless of your chosen economic model. To understand this, it is critical to appreciate the concept of real options.

Social distancing preserves the option of continuing to social distance if the mortality rate of the disease converges toward the higher estimates, or if it appears that an effective treatment, a vaccine, or another less expensive mitigation strategy is within close reach. Given our uncertainty about coronavirus mortality and even a remote potential for game-changing interventions, this option is incredibly valuable and well worth preserving.

If we decide to end social distancing now, by contrast, then we cannot effectively switch to social distancing if it turns out that mortality is high, or that we need “just a little more time” to achieve a breakthrough treatment or vaccine. Once the virus has spread widely, there is a point of no return. Epidemiologists tell us that a choice now to prioritize the economy and end social distancing would be an effectively irreversible decision.

In contrast, engaging in social distancing now preserves the option of changing our mind later in the face of new information. This is what we mean by a “real option”. It stems from the asymmetry in the reversibility of our present decisions — the choice to continue extreme social distancing in the present preserves the most flexibility in our future response.

The option value benefit of maintaining social distancing in the short term can be easily illustrated quantitatively through a hypothetical example that — for the sake of argument — heavily stacks the deck in favor of ending social distancing.

Suppose for our hypothetical that each week of social distancing causes extreme effects on our economy that are equal to a weekly drop in GDP by 50% — worse than even President Trump fears. A week’s worth of social distancing therefore costs about $200 billion. In addition, assume that the economic value of saving a life is $2 million — an artificial figure much lower than anyone who engages in the fraught task of putting a value on life would typically suggest. We have thus made two assumptions that incline us to end social distancing by deliberately placing our hand on the scale to make the harms of social distancing implausibly large and its benefits (number and value of lives saved) implausibly low.

Finally, let’s assume that Covid-19 spreads according to the baseline assumptions of an epidemiological model available on the New York Times website and that there is a 90% chance that it is .8% (“low mortality”), and a 10% chance that it is 4% (“high”). In two weeks, let’s imagine we will know the true mortality rate, or at least be able to rule out one of the extreme possibilities. Assume that three months of social distancing dramatically reduces mortality under both scenarios.

Further assume, as shown in Table 1, that there is a 90% chance that the number of lives saved by social distancing for three months relative to going back to normal today is slightly greater than 800,000 (if mortality is low) and a 10% chance that the number of lives saved is roughly 4 million (high mortality). At an economic value of $2 million per life, three months of social distancing brings economic benefits of $1.6 trillion with 90% probability, and a benefit of $8.0 trillion with 10% probability. Because the cost of social distancing for three months is $2.7 trillion, a simple cost benefit analysis of social distancing recommends ending social distancing now because the expected costs exceed the expected benefits.

Nevertheless, we should still engage in social distancing for at least the next two weeks. At $200 billion a week, two extra weeks of social distancing incurs a cost of $400 billion. If mortality turns out to be low, then this $400 billion would be a waste, and we should end extreme social distancing in two weeks. But we should still want to pay the $400 billion to retain the option of continuing with social distancing for another 2.5 months if mortality turns out to be high and social distancing for three months therefore desirable. In this case, social distancing yields a net positive economic benefit of $8.0 trillion- $2.7 trillion-$400 billion=$4.9 trillion — a vast amount. It is worth paying $400 billion to retain the option of doing something with a 10% chance of being worth almost $5 trillion. Even in an extreme model that makes social distancing artificially unattractive, social distancing still turns out to be the right move in the short run.

In sum, the real option value of social distancing in the short term can be enormous, even if it is very likely that we will end the practice in the future due to its economic costs. Over the next couple of weeks, social distancing is the right move under almost any set of assumptions.

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