Friday, March 20, 2020

Can the Economy Just Be Put on Hold for a Few Months?

The COVID-19 pandemic is an intertwined public health and economic event. Here are some comments from Richard Baldwin and Beatrice Weder di Mauro: "The social distancing policies are purposefully inducing an economic slowdown. ... The recession, so to speak, is a necessary public health measure. ... The recession is a medical necessity. That’s a given. But governments can and should try to flatten the economic recession curve. ... The key is to reduce the accumulation of ‘economic scar tissue’ – reduce the number of unnecessary personal and corporate bankruptcies, make sure people have money to keep spending even if they are not working."

The comments are from the "Introduction" to an e-book containing 24 short essays edited by Baldwin and Weder di Mauro, and just released by VoxEU: Mitigating the COVID Economic Crisis: Act Fast and Do Whatever It Takes. This is a follow-up to the ebook they produced less than two weeks ago, which I commented on in "Some Coronavirus Economics" (March 11, 2020). The collection has a lot of interesting analysis about fiscal and monetary policy in the current setting, along with specific discussions of the European Union, the European Central Bank, Italy, Germany,  China, Singapore, South Korea, and so on. 

Here, I want to focus a bit on a theme that comes up in a number of the essays: the idea that sensible economic policy can put the economy in the freezer for a few months, and the pull the economy out of the freezer, thaw it out, and restart it. I find myself in the awkward position here of largely being in agreement with this policy as a short-run approach, and at the same time also feeling that the ultimate consequences of the policy are going to be more difficult than a number of authors are envisaging. 

As one example of this theme in the book, Luis Garicano writes: "[A]t this point standard demand management is useless. Governments do not want to stimulate economic activity —they are doing all they can to stop it (they are asking people to stay at home!). Instead, economic policy is needed to ensure that the economy survives a ‘freeze’ of (hopefully, no more than) three to six months." 

As another, Pierre-Olivier Gourinchas writes: 
[I]n the short run, flattening the infection curve inevitably steepens the macroeconomic recession curve. Consider China, or Italy: increasing social distances has required closing schools, universities, most non-essential businesses, and asking ost of the working-age population to stay at home. While some people may be able to work from home, this remains a small fraction of the overall labour force. Even if working from home is an option, the short-term disruption to work and family routines is major and likely to affect productivity. In short, the – appropriate – public health policy plunges the economy into a sudden stop. ... A modern economy is a complex web of interconnected parties: employees, firms, suppliers, consumers, banks and financial intermediaries… Everyone is someone else’s employee, customer, lender, etc. A sudden stop like the one described above can easily trigger a cascading chain of events, fuelled by individually rational, but collectively catastrophic, decisions. ... To a first-order approximation, I would consider that governments may need to provide income support on a scale roughly comparable to the output lost.  
Rather than quote from a number of other authors, I'll try to sum up the economic policy goal in my own words. Sure, in normal times, it makes sense to have a dynamic economy where firms rise and fall depending on whether customers are willing to pay for what they produce, and it makes sense for a churning labor market to reallocate workers back and forth across these companies. 

But the novel coronavirus isn't a normal time. There is no reason to believe that it is a socially useful mechanism for sorting out which firms should expand or contract, or that it is a useful mechanism for reallocating labor across the economy. Instead, the goal of public policy should be to prevent firms from needing to fire workers permanently as a response to the pandemic. If firms need to use short-term layoffs, then government can help to replace lost income until workers get the call-back to return to work. The financial sector should be encouraged or subsidized to hold back on calling in loans or foreclosures. In some broad sense, the costs of an economic "freeze" due the coronavirus pandemic should be socialized. In the US, for example, perhaps the debt/GDP of the federal government rises by 5 percentage points of GDP, as the government provides support for the lost income across the economy.  

As I said earlier, I broadly share this vision of aggressive government action to ease the immediate economic burden of the pandemic. If the issue was as simple as whether to cut interest rates and raise government debt by 5 percentage points, then the policy choice would be simple for me. But ti's not that simple. 

1) As a matter of public health, there's no guarantee that COVID-19 is a one-time event. For example, the Great Influenza Epidemic of 1918-20 happened over three cycles. There is some reason for concern that in a globalized world, outbreaks of pandemics may be more common and spread faster than in the past. Even as we plunge into the immediate economic rescue, it's worth asking: Is this a pattern of public health and economic actions we are planning to repeat each year for the next 2-3 years? If such pandemics recur more frequently, is the the set of policies we are planning to follow once or twice a decade into the foreseeable future? For example, if very large fiscal policy actions to soften the economic blow of pandemics are going to be a recurrent and standard policy moving ahead, governments need to start planning ahead for them. 

2) The proposed plan as a matter of practical politics and legislation, will be able to turn on the rescue and then turn it off? For example, Olivier Blanchard offers this advice in the book: "[S]pend what you must on crisis containment and commit to wind down everything once the crisis is over. Full stop." The commitment to turning off the support is easy to say, but often hard to do, and the "winding down" process can extend a considerable time. 

3) As another matter of practical politics, support for business often tends to favor the big and the prominent. For example, in a US context there has been talk of assisting the airlines, which are big prominent companies, often with unionized employees, and thus lots of political clout. However, the tourism, entertainment, and restaurant industry is made up of much smaller firms, although as a group, they employ vastly more people.

4) It's easy to say that companies shouldn't be forced into bankruptcy by the coronavirus, and by and large, I agree. But we all know that some economic actors are more prudent than others. Some companies take on very high levels of debt, and some don't. Some people make sure to an amount equal to several months of income on hand, and others (who have similar levels of income) are rolling over large credit-card bills and paying interest from month to month. Yes, the pandemic was unexpected, but some firms and people build in a cushion deal with the unexpected, and some don't. Whenever government steps in to help those who are blindsided by an unexpected event, it benefits those who were not prudent over those who tried to be.

5) Finally, I'll add that any economy is not just a machine that can be switched off and on again. Helping households and firms to limp through the economic effects of this pandemic is worth doing, even at high costs to governments. But the economic disruption has costs of its own. Some number of the projects that companies were working on will be forever uncompleted. Relationships within and across organizations have been disrupted. It seems unlikely that customers and supply chains will simply restart their old patterns after a substantial disruption. Trust in providers will be shaken, sometimes for good reasons and sometimes for trivial ones.  There may be jump-starts toward companies doing more work online, or encouraging telecommuting. In health care, there may be shifts toward virtual consultations, or pharmacists providing more services, or how tests and treatments are approved and used. There may be surge to online education: after all, if online education is good enough for grades and credit at Harvard, Stanford, doesn't that show that it could be online at lots of other places after the pandemic passes? These pattern shifts and many more will outlast the pandemic itself, and will cause economic disruptions and costs of their own.