How to survive the pandemic
The coronavirus is sending shockwaves around the globe. Creon Butler considers the economic implications for a world that has practically ground to a halt
The world has never before seen a global economic shock like that from COVID-19. It is still far from clear when and how it will end. But at least some of the key parameters for determining how we should design our response – both to save the most lives and minimize the economic loss – are becoming clearer.
What we know so far
The disease is highly contagious, much more so than seasonal flu. A high proportion of the world’s population may ultimately be infected, although, for some 80 per cent the risk of death – or even serious illness – is thought to be low.
Mortality risk among the elderly – those over 70 – and those with underlying health conditions is much higher but can be reduced significantly provided there is adequate intensive care capacity in the health system to treat all those who need it.
The top priority of public policy is therefore to slow the progress of the virus, spreading out the incidence of cases over time and ensuring the peak is lower. This reduces the risk that hospital intensive care units will be overwhelmed, but also gives health systems more time to prepare by building new intensive care capacity and developing new treatments. It also ensures the health system maintains capacity to deal with other urgent medical needs and that other essential services in the wider economy can be adequately staffed. Currently, the only way to delay the spread of the virus is through strict ‘social- distancing’ measures; in particular, requiring people to avoid non-essential gatherings, large or small, and work from home as much as possible.
While several countries started with voluntary measures, they have quickly had to move to compulsory measures – closing meeting places, such as bars, restaurants, theatres and non-essential shops, as well as schools and universities, and imposing internal restrictions on travel.
Many countries have closed their borders to non-nationals. Some of those that took strict measures at an early stage have apparently managed to check the spread of the virus with a relatively low number of confirmed cases and deaths.
Not surprisingly, strict social distancing imposes an enormous cost on the economy, simultaneously restricting both demand and supply. It is, therefore, different from both a financial crisis and wartime. Leisure services were hit first, as well as manufacturing businesses dependent on international supply chains, but the effects will quickly become economy-wide as the strict measures are imposed.
Second round effects will include: very sharp falls in equity prices; the likelihood of reduced lending capacity and a lower appetite for risk in the financial sector, even though partially offset by government measures; and shortages of essential workers due to people being infected, or having caring responsibilities.
By contrast, some areas of the economy are receiving a strong demand boost due to the crisis, particularly some kinds of online shopping, supermarkets as people switch from eating out to eating in, suppliers of medical equipment and tech companies supporting the shift to home working and entertainment.
There is bound to be further adaptation, helping to sustain output, even with strict social distancing in place. During the ‘three-day week’ imposed for two months during the coal miners’ strike in 1974, the British economy managed to produce four and a half days’ production in three days.
Changes in the composition of output and the development of the internet and online working since then may mean the scope for adaptation is even greater now. Some companies will be able to shift production from non-essential to essential areas – for example restaurants moving from dining in to takeaway.
In the initial phases of a recovery, when social distancing is partially relaxed, there could be opportunities on the supply side to take advantage of the suspension in activity to bring forward maintenance and retooling – for example moving factories from petrol/diesel to electric car production.
How fast and how far adaptation goes will depend on how long the crisis lasts and government action, for example in supporting small and medium enterprises trying to move their business model online, in supporting large companies that are ready to retool and re-deploy resources and in its willingness to fine tune the social-distancing guidance in the light of experience.
Whatever the scope for adaptation, and notwithstanding the likelihood of a strong demand boost after the crisis is over, there is no doubt that strict social distancing will substantially cut output in the short term.
Surveys of business activity are already showing unprecedented falls, while the first hard figures for the US showed unemployment up an unprecedented 3 million in one week. The authorities are also concerned that strict social distancing may be hard to maintain for a lengthy period of time, particularly where people are living in cramped accommodation in cities or are suffering from loneliness.
The next phase
There is, therefore, an urgent need to relax or adapt strict social distancing as soon as possible, consistent with limiting the loss of life. Experience in China suggests that even a serious outbreak can be brought to a halt within 12 weeks, provided social distancing is strict enough. Experience in South Korea and some other Asian countries suggests that a combination of extensive testing, contact tracing and quarantine measures may be able to reduce the risk of a second wave of infections as the economy is restarted.
But each country’s experience is different, and the exit route for North America and Europe will depend crucially on a complex mix of medical, technical, behavioural and economic questions.
It is important that these be modelled together, rather than independently, and the key trade-offs brought out. For example, boosting spending even higher now on intensive care and other treatment capacity as well as testing and contact tracing, may allow a government to ease social distancing faster and so limit the economic damage to the economy without costing lives.
Similarly, reducing as far as possible uncertainty on the extent to which the virus has already spread, what happens when human-to-human transmission is halted by social distancing, and the likelihood of natural immunity emerging in the population, will contribute substantially to developing the most cost-effective economic policy response.
The economic response
So far, central banks and finance ministries have acted on an unprecedented scale to counter the impact of both the first-round demand and supply effects and the subsequent imposition of social distancing in many countries. Actions so far have included:
- The promise of unlimited funding for health systems to enable them to meet the costs of the crisis.
- Cutting interest rates effectively to zero and a vast expansion in the size and scope of quantitative easing.
- Easing macroprudential constraints on the banking system to allow them to expand lending with the same capital.
- Provision of very low-cost liquidity support to businesses, for example through new term lending facilities from central banks via the banking system and government guaranteed loans.
- Ensuring mortgage lenders and landlords provide temporary relief to borrowers and tenants when needed.
- Waiving and deferring taxes on businesses.
- Strengthening the benefit system by increasing the availability of sick pay, but also provision of generous wage subsidies to keep people in work.
- In some cases, direct payments to individual citizens or taxpayers – HK$10,000 in Hong Kong, $1,200 and $500 for each child in the US.
- Direct grants to business and equity investments in some of the worst affected industries.
- Arranging dollar swap lines between central banks to underpin international dollar liquidity and the functioning of the foreign exchange markets.
- New packages of assistance from both the International Monetary Fund and World Bank, which have also called on official bilateral creditors to suspend debt payments by the poorest countries.
These responses continue to evolve rapidly. Underlying them are some key judgments which will play a major role in determining the long-term impact of the crisis, both in terms of the shape of the economy once the crisis has passed and the eventual cost to taxpayers.
First, what balance to strike between liquidity support and permanent transfers?
Choosing liquidity support keeps costs down, particularly in the event that the crisis is short-lived and the post-crisis recovery is very strong.
But some firms and individuals will not take advantage of the liquidity support on offer, simply because they don’t know how much they will need, whether they will be able to pay it back, and if they can’t, whether there will be substantial debt forgiveness from the ultimate guarantor.
So permanent transfers are needed, too, and should be focused on maintaining the human and physical capital in the economy – wage subsidies to keep people in employment, mortgage and rent subsidies to keep people in their homes, equity investments in essential industries, such as airlines, to prevent bankruptcies. By increasing the likelihood that companies will stay solvent, permanent transfers will also protect the assets of the financial system, reducing the extent to which the government may subsequently have to inject new capital into the latter.
Second, how far to target interventions on those who are most in need of support?
Some countries have already made, or committed to make, direct payments to individual taxpayers or citizens. And it has been suggested that the crisis justifies bringing in a guaranteed minimum income, under which every family would be guaranteed a certain income, sufficient to live on, regardless of whether they are working or not.
This kind of approach may be the only way of reaching certain groups, particularly the self-employed or casual workers, and may in some countries be the fastest way to deliver aid, particularly if traditional benefit systems are initially overwhelmed by increased demand.
But it is likely to be more expensive than targeted approaches and so harder to sustain. And it may not command public support if those who clearly do not need support nonetheless benefit.
Wherever possible, it is therefore better to build on the existing social benefits, unemployment benefit and the tax system, adapting it as necessary to increase the level of provision and close gaps where needed.
Third, how to fund the vast increase in public expenditure?
It is clear that governments should allow automatic stabilizers to operate in full. But should they signal now how they plan to fund the additional expenditure in the long term? The vast boost in quantitative easing will reduce the immediate pressure on financial markets of additional government bond issuance, but central banks could go further and lend directly to finance ministries (monetary financing) or make cash gift themselves to individual citizens. This could signal the authorities’ willingness to provide unlimited support, but could stoke fears of long-term inflation and put downward pressure on the exchange rates of countries with weak current account positions. By contrast, stepping up issuance of long-term index-linked debt would signal the opposite – but at the expense of ruling out the ‘inflation tax’ option in the longer term. The best approach in the short term, given the present level of uncertainty, is to keep all options open and to support this by continuing the present pattern of debt issuance facilitated by quantitative easing.
Fourth, whether to make the exceptional support provided to business conditional on new policies to be adopted after the crisis is over?
One suggestion is to try and use this method to lock in faster action to mitigate climate change. The difficulty with such an approach – at least if applied across the board – is that it would slow down the provision of support, could make companies reluctant to accept help, and, in so far as the measures required involved imposing additional costs on businesses that were already struggling, be hard to explain to the public.
Certain types of conditionality, such as new taxes or restrictions on air transport, might only make sense if they were internationally coordinated – which is unlikely to happen in the present environment. However, the opportunity for green conditionality could arise in the future if liquidity support needs to be converted into equity investments, and the government should, as far as possible, plan for this. Moreover, a government with a net-zero carbon emissions target should avoid providing support to high carbon intensity industries in a form and over a time scale which is clearly inconsistent with this objective.
Fifth, how much effort to put into trying to achieve an internationally coordinated response?
Coordination at a technical level among health experts has been strong from the start and has strengthened for central banks as the crisis has deepened. But the picture for governments and finance ministries has so far been much weaker, no doubt reflecting the Trump administration’s scepticism and contrasting with the strong G7/G20 coordinated response to the global financial crisis. It is critical for the international community to rectify this as soon as possible. Some measures can be a lot more effective when countries act together. These include: pooling resources in the search for a deployable vaccine and improved tests; implementing expansionary fiscal policy while minimizing volatility in exchange rates and debt markets; providing mutual support to countries in financial difficulty through the international financial institutions and regional mechanisms such as the European Stability Mechanism; and avoiding beggar-thy-neighbour trade and financial policies. Moreover, coordination could play a helpful role in facilitating the efficient lifting of travel bans when countries are ready to do so. A G20s leaders’ statement on March 29 touched on many of the rights issues, but lacked concrete collective measures.
In summary, the above approaches amount to the authorities ‘doing whatever it takes’, but in a manner which, as far as possible, controls the ultimate cost, maximizes the effectiveness of any given measure, preserves the existing organizational capital in the economy, and keeps the authorities’ longer-term options open.
The long-term effects
An economic shock on the present scale will have a lasting, and potentially transformational, impact on the global economy.
Companies and individuals are likely to place a much higher priority on economic resilience, not just regarding the risk of infectious disease outbreaks, but probably also a wide range of ‘unlikely but possible’ global shocks. Companies will reshape their supply chains, creating multiple sources of supply and possibly holding reserves of critical materials and equipment. They may also retrench within national markets, the more so if international coordination is perceived to have failed. And the crisis could give a strong further impetus to the redefinition of corporate purpose and responsibilities beyond simple profit maximization. Individuals are likely to demand greater social protection and stronger public health systems. We may also see a rise in saving in those countries where it has been very low and increased demand for private insurance. Similarly, while governments will be faced with much higher debt levels in the short-term, and will be ready to incur further debts to sustain the recovery, they are likely to put a high priority on reducing national indebtedness over the long-term.
But one of the most effective ways for governments to increase resilience will be to limit the risk of similar outbreaks in future. The experience with SARS, H1N1 and Ebola shows that, while some progress is made after each outbreak, this does not amount to a decisive and sustained campaign to minimize the risks of the kind of economic shock we are experiencing today.
It is to be hoped that the scale of the present crisis, and the vast disparity in cost now evident between preventive measures and dealing with an outbreak, will lead to a different outcome this time round.
This should include sustained and internationally coordinated, long-term funding of research on prevention – particularly searching for pathogens in rural and urban wildlife and monitoring human-wildlife transmission routes – but also of contingency response measures, such as the work of the Coalition for Epidemic Preparedness Innovations on rapid vaccine development.
Governments can work with each other to help companies increase resilience and redesign their supply chains in the most cost-effective way. This may involve creating new institutions – as the International Energy Agency was established to help deal with global oil shocks after 1973. And it is important to ensure this kind of collaboration is not prevented by an excessively broad interpretation of national security.
More broadly, the consequences for global economic governance are very hard to predict at this stage. If governments and their people conclude that international cooperation is the best way to protect against a future recurrence, one could see a boost to international economic cooperation going well beyond the immediate threat of infectious disease outbreaks.
On the other hand, if they conclude that the nation state – or a close alignment of states, such as the EU – is the only vehicle that can protect their community from such threats, one could see a rapid weakening in the multilateral economic system.
Other structural changes to the global economy are likely to include a major and permanent shift to online communication and meetings and working from home, as companies, and particularly small and medium enterprises, and other organizations invest in the necessary equipment and change working methods to suit the services available.
This has parallels with response to the ‘Millennium bug’ in the late 1990s, and this in turn could lead to reduced demand, or at least slower growth in demand, for office accommodation, public transport and air transport, but an increase in demand for domestic housing.
The crisis will probably accelerate the shift to online shopping and online entertainment through streaming services. We may also see permanently expanded output and new long-term participants in the medical equipment industry as a result of increased demand and the emergency private sector collaborations developed to produce ventilators and other essential equipment. Many countries, particularly in the developing world, may see a permanent boost to the share of health and research and development spending in their total GDP, as well as, for some, a shift in the delivery model from private to public.
Further structural shifts may occur if government measures to protect small and medium enterprises, the self-employed and individual sectors particularly exposed to strict social distancing are not fully successful leading to a permanent reduction in their weight in the economy.
The extent of the long-term changes in individual countries is bound to vary considerably. Countries with younger populations, a stronger ability to implement social distancing effectively, and better public health systems should see less severe effects than others. But given the sheer scale of the monetary policy and fiscal interventions government are having to take, the potential need for widespread recapitalization of parts of the economy, the new demands experience of the crisis will create, and the extent of the wider disruption to trade and investment flows, it seems a strong possibility that the crisis will finally shift many advanced countries away from the low interest rate, low productivity equilibrium seen since the global financial crisis.
AUTHOR: Creon Butler Research Director, Trade, Investment & New Governance Models: Director, Global Economy and Finance Programme
Πηγή: chathamhouse.org
