So much isolation, exposure to social media and conflicting information are generating in the people anxiety and anguish with not knowing what kind of country and economy awaits them once the acute coronavirus emergency is over. Will we have a job? How many stores, how many factories will be able to reopen? What should companies and their owners do? Are governments doing what is right? How long will the recession last? Is there light at the end of the tunnel and how long will it take to reach? What can we do for the world’s poor? Is the European Union up to the challenge? We economists have a social obligation to do our best to help people with answers, however imperfect they may be. The intent of this article is to raise some of the issues.
- Prediction models and their dilemmas
At this point, we know that the health crisis unleashed by the coronavirus has a lethal power similar to that of the Great Pandemic of 1918, the so-called “Spanish” flu, in which 40 million people died, 2% of the world’s population at the time. The subsequent economic downturn spanned a decade and created the breeding ground for nationalist revanchism and ultimately, World War II. Fortunately, the advancement of medicine and the ability to quickly adopt measures of social distancing could today shield us from this extreme scenario. Much progress has been made, it is true, but it is difficult to comprehend that a century later we still do not have the capacity for developing vaccines in a timely manner, nor do we have a health system capable of emergency response in the event of pandemics. This is a true dereliction of duty on the part of advanced societies, which we hope will be remedied after the present shock.
Nor has social science been able to develop a “vaccine” against economic recessions. Economics is certainly not an exact science capable of matching the effectiveness of medical vaccines, but so many trial-and-error exercises by governments do not seem justifiable at this point in history. Neither would it be fair to say that we know as little today or that we are making the same mistakes that were made during the Great Pandemic of 1918-1920 and the Great Recession of 1929-1932. It was not until Franklin D. Roosevelt assumed the presidency of the United States in 1933 and launched the “New Deal”—a package of anti-recessionary measures and economic stimulus—that the world economy began to emerge from the long tunnel. It was the lessons learned then that the United States applied in the 2008 crisis and which enabled it to overcome the recession in just over a year. Unfortunately, Europe did not learn the lesson and it took almost five years to return to growth. Meanwhile, the euro nearly collapsed in 2012. Has Europe learned its lesson by 2020?
Economists like to develop models to simulate and predict the future. Many of the curve charts that we see daily in the media, with estimates of the possible evolution of the pandemic, come from adaptations of a model developed in 1927 by two Scottish epidemiologists and bio-statisticians (Kermak and McKendrick), based on the experience of the Great Pandemic. When Angela Merkel warned in her much-quoted March 11 statement that 70 percent of the population would catch the coronavirus in several waves, she did so in line with this model. If a vaccine were not available in the foreseeable time and confinement was not applied, this would be the figure that would allow a progressive immunization of the world population and, as a consequence, the end of the pandemic.
The different trajectories of the simulations shown to the public depend very much on what measures are taken and how severe they are in terms of social distancing and the paralysis of economic activity. They also depend on how prepared health systems are to deal with the emergency, on the availability of protective equipment and, mainly, on the time presumed for a vaccine to be widely available. It would make a huge difference in terms of human lives and job losses if the vaccine were available in the early fall of this year rather than by mid-2021. Hence, the model projections regarding the number of infected, number of deaths and duration of the pandemic depend on so many variables and on so many choices that one must be careful when giving figures and time frames. To say that the emergency could last two months or 18 months does not help to guide the general public.
But what the models do make clear is that we are facing very difficult dilemmas when deciding what to do, encompassing sanitary dilemmas, economic dilemmas and ethical dilemmas. In the absence of a vaccine within a reasonable time, the higher the number of people who become infected and immunized, the faster the pandemic ends and the sooner economic activity can resume, but at an absolutely indefensible cost in lives. There is also a clear trade-off between social isolation and economic activity, between health and employment: the more severe and long-lasting the social distancing measures are, the greater the cost in terms of job destruction and economic recession. On the other hand, the more severe the social distancing and hence the higher the economic cost, the more need there will be to relax social distancing at some early point at the risk of second and third waves of contagion, because not enough people will be immunized. Unfortunately, these dire dilemmas that governments are facing have no way of being subjected to democratic scrutiny beforehand, despite the fact that they can affect the life or death of millions of citizens. This is the time for politicians: the burden of decision rests on them. Voters will have the duty of rewarding or punishing them for their performance only later on.
Faced with the uncertainty of vaccine availability, almost all countries—except for sad exceptions such as Mexico or Brazil—have adopted the objective of “flattening the curve” of the epidemic through social distancing as the target of their health and social policy. This is a sensible policy. The criterion to define the level where you want to flatten the curve is the number of infected that the health system of each country can handle without being overwhelmed. Again, there is a trade-off between the quality of the health system of a country and the cost of economic paralysis you have to accept to tame the pandemic: the better the health system, the less severe and shorter the social distancing measures need to be and the fewer jobs are lost. We can harbor reasonable optimism that well-organized countries are going to flatten the infection curve relatively soon. May-June seems to be the moment in which—very progressively—some activities could be restored, with due precautions. Time frames will be very different in poor countries where many people cannot afford to stay at home and their health systems are riddled with inefficiencies and scarcity.
- How serious will the recession be?
Social distancing measures have placed the economy in an “induced coma” state. The question people are asking is how long the coma needs to last and, as a consequence, how deep is the recession is going to be. The severity of the recession, in the first place, is a direct function of the severity of containment or social distancing policies, either because the government suspends certain activities that involve contact between people or because people prefer to isolate themselves for fear of contagion. Second, the magnitude of the recession will depend on how long the containment lasts. Every week that lapses under quarantine, new jobs are lost and more productive capacity exits the economic cycle.
The recessive effect of social distancing occurs in concentric circles, initially affecting a first group of non-essential activities and then moving towards more nuclear ones. Inside a company affected by the first waves of activity restriction, owners will normally try to preserve their future viability by keeping essential personnel in the hope that the reopening will happen soon, until the passage of weeks makes it unsustainable to maintain even this key personnel.
The recession evolves at a double dimension: demand and supply. The demand collapses because, firstly, the purchasing power of dismissed workers falls and, secondly, because consumer confidence disappears and people refrain from buying in the face of general uncertainty. On the supply side, factories and services close primarily by decree. Others have to follow suit due to a general interruption of supply chains or to general low demand. Both sides of the coin—demand and supply—escalate by feeding each other.
The final blow to companies and consumers in times of recession comes from the closing of bank credit. Banks stop lending or demand repayment of credits at the prospect of a crisis that may make a company not viable or a consumer insolvent. The banks do not even lend to each other, because they do not know how their accounts receivable are affected or how much their balance sheet—their investment portfolio—has been impacted by the collapse of the stock market. The widespread mistrust ends up spreading to the government, because the fall in tax revenue and the immense burden of unemployment and health benefits will seriously affect the Administration’s ability to pay its obligations and also its ability to issue new debt at reasonable interest rates.
Data on the fall in economic activity in the world is already beginning to appear. It shows that the deterioration is happening at breakneck speed. In China, economic activity in the affected areas fell 40% in the first quarter of 2020. In the United States, in the week ending March 21 alone, when social distancing measures had barely begun, 3.3 million Americans went into unemployment. 14 million workers are expected to have lost their jobs in early June, bringing the unemployment rate from 3.5% to 20%. Goldman Sachs estimates that US GDP will fall 24% in the second quarter of this year. In Spain, the fall in GDP for the second quarter is estimated at 14% … These deterioration figures at the start of a recession are truly unprecedented.
- Flattening the recession curve
The good news in this brutal start to the recession is that this time it seems that governments and central banks have taken seriously their task to give their respective economies a parachute against free fall. They have announced the intention to put together relief packages that guarantee unemployment benefits to all those dismissed by social distancing measures, that provide direct aid to families and give financial oxygen to companies to avoid closures. Central banks have promised to put in place securities purchase schemes that will provide liquidity to governments in order to increase spending levels and to banks to avoid credit contraction.
The message that the fiscal and monetary authorities have sent in unison is that “they will do whatever it takes” to keep workers, households, companies and public administrations afloat. To give just a few examples, the United States has approved a package of 2 trillion dollars, equivalent to 10% of GDP, Germany has promised resources over 750 billion euros (21.3% of GDP) , France around 350 billion euros (14.2% of GDP), the United Kingdom 350 billion pounds (15.8% of GDP), Spain 200 billion euros (15.7% of GDP). To this must be added liquidity assistance programs, such as the one approved by the European Central Bank for 750 billion euros or the Bank of England for £200 billion. So many zeros are dizzying, but if we look at the proportions over GDP figures, we see that they are truly extraordinary.
Since no one knows how long the health emergency and isolation measures will last, the approved packages aim to sustain the economy for the next three to four months. If containment measures continue beyond that time, new emergency funds will have to be approved. Governments have promised “whatever it takes” to preserve the vital signs of the patient in an induced coma.
I think the amounts approved so far are adequate for this first round of severe isolation. Where I don’t feel so comfortable is in the choice of instruments as well as in the neglect of certain uses of the funds. Government experts are still caught up in the pattern of past rescue package thinking. But this time is different because the government itself has induced the coma of the economy. Apart from preserving people’s minimal living conditions, the objective must be to keep jobs and businesses alive. This goes beyond offering liquidity to companies and banks through guaranteed lines of credit. Credit is not the appropriate instrument under current conditions. No one is going to be able to repay those loans, anyway.
Regarding the use of these funds, governments must assume in the real economy the same role that central banks traditionally play in systemic financial crises, that of “lender of last resort”: providing as much liquidity to financial institutions as is necessary to meet all their obligations. Some economists have coined the apt term “buyer of last resort” to define the government’s new role in the real economy during the coronavirus emergency. The absolute priority is to guarantee employment and keep companies alive, covering all their operating costs, with no greater requirement than maintaining jobs (“no questions asked”). Administrations have enough information to know the level of costs in each company. Reasonably enough, owners and stakeholders will have to put some skin in the game, but not to the point of forcing them to close their companies. Achieving this objective is essential to avoid the total collapse of economies, because no one should be under the delusion that companies open or close simply by turning a key. When companies close doors, a high percentage of them are not able to reopen, with the consequence that this productive and job-generating capacity disappears permanently and the country becomes poorer. The objective must be that the fundamental pillars of economic activity still be in place when the health emergency gradually passes.
We must also realize that the programs approved are not to stimulate or revive the economy, but simply relief measures. It could not be otherwise. There will be time afterwards to launch infrastructure investment programs that revive economic growth. However, there is an inexplicable omission: the urgent investment in health systems. The pandemic has shown that the emperor has no clothes. Decades of underinvestment in public health infrastructure, in production of medical equipment, in research and development, etc. have led to current deficiencies. One way to alleviate the health emergency in the short term would be to condition the support to companies to their contribution to overcoming the emergency. Depending on the characteristics of each company, some may redirect their productive capacity to manufacturing protective sanitary material or respirators. Many empty hotels can be converted to field hospitals or quarantine sites, as has already been done. Airlines could redistribute the sick to destinations with idle capacity. This is the same logic as the economics of war, where companies reorient themselves towards the objective of producing war materiel.
- Call the helicopter, and don’t forget the world’s poor
So where is the money going to come from for these relief programs and then for reactivation? Aside from two or three very large and solid economies, which certainly do not include any of the southern European countries, governments have no way to finance these programs through the orthodox means of issuing debt today and repaying it with future taxes. Nor are the capital markets willing to lend to insolvent governments. So the only way to finance the programs is to use the privilege reserved to the state to create new money and distribute it without asking for anything in return. The most common and elegant way to create money is for the central bank to lend money to the government through the purchase of debt securities at very low interest rates. These titles, or others that replace them, will remain on the central bank’s books per secula seculorum or until inflation dilutes them.
Lately, the figure of “helicopter money” and the so-called Modern Monetary Theory—which is not as modern as its name indicates—has become fashionable. It has been mainly claimed in recent years by left-wing politicians to justify the expansion of public spending.. Its central postulate is that governments can increase spending and run fiscal deficits by resorting to central bank financing, which can create money freely, as if the government were throwing money from a helicopter. The only limitation is the inflation that “inorganic” money can generate—that is, money not matched by an increase in production.
Interestingly, orthodox economists (with the exception of the Dutch and German ordo-liberals) are progressively accepting the idea of helicopter money in critical moments like the present, because they currently see no risk of inflation, rather a risk of deflation due to the coronavirus crisis. This position certainly has merits today. It means that governments can face the crisis without restriction in the availability of resources, which is very good news for citizens.
Monetary “orthodoxy” is not going to be the sole victim of the coronavirus crisis. The liberal conception of the state, according to which it must interfere as little as possible in economic life, will be shattered. We will return to the era of the large interventionist state, owner of companies, that Leviathan that has been so much criticized in recent decades. When the crisis associated with the pandemic passes in two or three years’ time, it will take us a long time to bring back the state to a more reasonable size, which will be probably still larger than it was before the pandemic. Here too, nothing will be as it used to be.
If the world has already accepted that relief programs are going to be free for governments and citizens at the end, can the helicopter also fly over poor countries? It has become fashionable to say that the coronavirus has made the poor and the rich equal. This is a great falsehood in the case of the poor in poor countries. Firstly, because the number of infections and of deaths will be much higher in poor countries. Their health systems are not ready to take care of people’s health even in normal times, much less in these times of pandemic. Furthermore, social distancing measures will not work in the poorer strata. For them, staying at home is not being able to eat, because only on the street do they find their daily sustenance. Between starving or catching the virus, the choice is clear. Governments do not have the financial or administrative capacity to implement the social protection network that allows poor people to stay at home, not to mention the fact that they live in crowded homes and slums.
And secondly, because the governments of poor countries will not have sufficient financial means for sustaining relief programs, let alone handouts. On the one hand, the economic situation was already worsening because of the world crisis, which has had an impact on reduced exports, weaker currencies and capital flight. Even before the coronavirus crisis, poor countries´ debt capacity had been reduced to nothing. And if they decide to fly their own helicopter, what will rain down is increasingly devalued local currency that does not buy medical supplies or imported food, but does generate high inflation.
We are facing the perfect storm of an unprecedented humanitarian crisis. I know it is not easy for the battered first world, but the coronavirus should not lead the developed world to withdraw behind its borders. Sooner or later, the impact of the overwhelming health crisis in poor countries in Africa, Latin America, the Middle East and Asia will end up feeding the epidemic back into rich countries. The G7, G20 and multilateral agencies can do a lot to mobilize resources towards poor countries, in their own interest as well as for international solidarity.
- The existential dilemma of the European Union
Europe needs to fly its own money helicopter as other countries have done, including China and the United States. The problem is that the European helicopter, the ECB, is the collective property of the members of the European Monetary Union (EMU). No individual country can force the ECB to buy the debt securities with which it is financing its coronavirus emergency program.
This is the core of the dispute between Northern and Southern Europe. Theoretically, Germany, the Netherlands or Austria can cope with the emergency through orthodox means of issuing debt and collecting taxes. Southern European countries, including France, do not have the fiscal leeway to do so. The 750 billion promised by the ECB are just to provide liquidity to financial markets, not to keep millions of companies and workers on life support. The resources theoretically available through the European Stability Mechanism (ESM) are, first of all, totally insufficient and, secondly, subject to a conditionality that is inadequate for facing a crisis such as the coronavirus. Only some kind of common bonds (coronabonds) could work, whose service and repayment would be borne by the European budget. Another thing that would also work would be a sufficiently significant extension of the ECB’s commitment to buy the debt securities of the member countries. In the end, both mechanisms imply creating a common European pot to deal with the crisis, a solidarity that a part of Europe is in denial about accepting.
The European helicopter can only fly if all the members agree. To buy some time, the European Union has temporarily exempted its members from complying with the fiscal deficit caps established in the Stability and Growth Pact, but sooner rather than later many southern European countries will find that nobody is willing to lend them money at reasonable interest rates.
How can the EU and its EMU survive such a discrepancy? This conflict nearly cost the euro its life in 2011-2012, until the ECB President, Italian Mario Draghi, said he would do what was necessary to save the monetary union. Will the ECB again, this time under the command of France’s Christine Lagarde, have to save the EMU in extremis by buying the bonds of France, Italy or Spain? This will probably happen, forced by circumstances, but I do not predict a good end to a monetary union with such profound discrepancies and such divergent fiscal policies. In principle, no country can be forced to bear the costs of others. The thing is that we are not talking about just any countries, but members of a monetary union. Theory and experience tell us that without a minimum of solidarity a common currency is not viable. Okay, a German economist would say, but first let Italy or Spain do their homework and balance their fiscal accounts. He might be right, but the truth is that this will not happen. Italy is Italy and Spain is Spain. And so it goes round the never-ending discussion between the North and the South.
The truth is that these divergences have paralyzed Europe. Suffice it to see how the coronavirus emergency has been addressed: it has been a blatant withdrawal to national decision-making, as if 70 years of European integration had not existed. Even internal borders have been raised again in clear contravention of the Schengen Agreement. Each country is managing the emergency as it sees fit; a return to autarky, the main responsibility for which lies in Brussels with its inability to articulate European responses to the crisis. Once again, Europe is risking its future. In other crises it has managed to get out of the jam relatively unscathed. Let’s hope it happens again.