Economists usually worry about bailing out private firms and increasing national debt. But right now, we should be doing both

In a Covid-19-induced crisis the usual rules do not apply

March 17, 2020
HM Treasury. Photo: Kirsty O'Connor/PA Archive/PA Images
HM Treasury. Photo: Kirsty O'Connor/PA Archive/PA Images

As so often in economics, it’s about supply and demand; and remembering that both matter. The first and most obvious impact of the pandemic will be on supply. The most important input to any economy is labour; and both covid-19, and more significantly the measures taken to contain it, will reduce labour supply. If people are sick, if they’re self-isolating because they think they might be sick, or if they’re looking after vulnerable relatives or children who can’t go to school, then they can’t work. Other measures—closing down travel or theatres—will also reduce the productive capacity of the economy.

All this will reduce GDP by quite a lot; a severe recession seems inevitable. What should policy do?

About the immediate consequences—absolutely nothing. These impacts are the direct result either of covid-19 or of necessary public health measures to reduce its human damage. They are part of the cure. If the result is that GDP falls 2 per cent or 10 per cent next quarter, so be it.

But the indirect impacts are a different matter. If businesses are closed, or lay off workers, incomes will fall; and fear and heightened uncertainty will reduce spending (even if stockpiling leads to a temporary spike in demand for some products). The prospect of mass redundancies in the transport and hospitality sectors may be only days away.

Policy can address this. And it should. The direct disruption to supply from covid-19 will be temporary—the vast majority of us, and the businesses we work in, will be just as productive when this is over as we are now. But the hit to demand could do permanent damage to the economy’s capacity. If businesses—from airlines to pubs—close down, this is likely to reduce output not just temporarily but for a very long time to come. As for workers who lose their jobs, they are likely to be unemployed for a while—and even after that to be reemployed in lower-wage, lower-productivity employment. If we let this happen, the “scarring” effect on the economy could be considerable. But there’s nothing inevitable about it at all—with good policy, there’s no reason we can’t avoid it.

So what can we do? The answer is simple, even if the policies are not. We need to stop firms laying people off and stop them going bust. That means subsidising firms to keep employing and paying workers, even if they don’t actually need it; helping to pay or delay their bills; and implementing programmes to allow banks to delay loan repayments.

In short, the government should bail out the private sector. Normally this would be anathema to economists. Allowing less efficient businesses to fail, so that their resources—capital and labour—can be redeployed to more efficient ones, is one of the key ways in which an economy becomes more productive; Schumpeter’s “creative destruction.” And we also worry about “moral hazard”—that if you provide what is in effect insurance against bad luck or bad decisions, businesses will be more likely to take risks that will lead to that insurance becoming necessary.

Neither of those considerations really apply here. Destruction is not “creative” if it hits good and bad businesses alike at random; nor will a long period of economic stagnation (at best) be conducive to the growth of new, more productive firms. And given that insurance companies have quietly excluded pandemics from coverage for business disruption since the SARS epidemic, moral hazard is a distant concern. It’s hardly reasonable to suggest that your local Thai restaurant should have made a business plan that took into account the risk of a three month pandemic-induced shutdown.

The crisis is also likely to expose the damage done, both economic and social, by the cuts to public spending over the last decade. The deliberate erosion in the value of welfare benefits was a false economy, making both individuals and the economy as a whole more vulnerable to economic shocks, and potentially magnifying the impact. But we can reverse this; much more generous statutory sick pay, and immediate increases to Universal Credit and tax credits, would channel money to those who both need it most and are most likely to spend it.

The fiscal consequences of all this are essentially irrelevant, certainly in the short term. Market reaction to the crisis has been to force interest rates on long-term government debt in the US, UK and eurozone to the lowest levels in recorded economic history; investors are willing to pay governments for the privilege of lending them money. If we’ve learned anything from the aftermath of the financial crisis it should be that the role of government is to sustain demand, and that worrying about the impact on debt and deficits of the necessary spending is the economic equivalent of anti-vaccination scaremongering. Even George Osborne seems to have grasped that, albeit a bit late. The measure of policy success is not how much the economy has shrunk in three months, or how large the deficit is; it’s whether in two years we’re back on a normal growth path or not

So President Macron has got it broadly right with his pledge to ensure that “no business, whatever its size, will face risk of bankruptcy”; backed up by up to €300bn of loan guarantees. By contrast, the UK response looks, at best, behind the curve. It’s not too late to avoid making a depression out of a (crisis-induced) recession; but we don’t have long.