April 8, 2020 / 12:43 PM / 4 months ago

Breakingviews - Hadas: Beware of excessive economic gloom

LONDON (Reuters Breakingviews) - Worry about the coronavirus pandemic, definitely. Worry especially about poor countries where social distancing is difficult and medical resources are scarce. Worry about the exit strategy for lockdowns and the damage to mental health from isolation. But do not worry too much about the economy.

Cyclists ride over an almost empty Westminster Bridge, as the spread of the coronavirus disease (COVID-19) continues, London, Britain, April 8, 2020.

Yes, much of the developed world is entering the most dramatic recession in decades. Gross domestic product in Europe and the United States could run at a 25% lower rate than normal, with unemployment rates rising correspondingly. Yes, major industries such as travel, and tourism have temporarily shrivelled to a tiny fraction of their pre-virus scale. And yes, the gradual restoration of business activity and lingering worries about renewed outbreaks is likely to delay a full return to pre-coronavirus conditions.

Still, past the short term, the appropriate level of economic gloom is somewhere between low and moderate. To see why, consider the effects of the fight against Covid-19 on six crucial aspects of any successful economy.

Physical capital is almost unscathed by the virus. Factories are still intact, and almost all of them are ready to be scaled up to meet the demand which is being pent up in isolation. The same goes for service industries. Though restaurant trips and movie visits are lost for good, the desire for parties, plane trips and conventions will be huge when they are finally allowed again.

The same goes for technological progress. The infrastructure of brains, equipment and lines of communication is still in place. The closure of laboratories and research facilities will slow down development in some areas. The next generation of smartphones and smart toasters will take a bit longer to arrive. On the plus side, the massive efforts devoted preventing the coronavirus and caring for its victims will almost certainly bring collateral benefits.

Human capital is undoubtedly being eroded. Months of enforced idleness and lost education, not to mention the psychological damage from fear and isolation, will leave scars. However, assuming that restrictions start to be eased reasonably soon, the long-term damage is likely to be modest. Most furloughed workers can slot back into their old jobs, provided their employers are still in business.

The pandemic has demonstrated the importance of active and efficient government. Just compare South Korea’s successful crisis management to American dithering. At the same time, the crisis has demonstrated the importance of solid large companies that can take care of their workers and show initiative. The post-crisis economy is likely to have governments which are more competent, more trusted, and less instinctively anti-business.

Disaster resilience was not on many people’s minds a few months ago, but its economic importance is now crystal clear. Countries and companies are certain to strengthen early warning and fast response plans and build up greater inventories of key products. In other words, the global economy should be better prepared for the next calamity.

The money system is also getting through this crisis in pretty good shape. In many developed countries, cash distributions to temporarily unemployed consumers and financially squeezed businesses mean there should be enough money in the right hands to pay for all the goods and services that can be produced. In due course, this flood of money may create difficulties, but a shortage of spending power should not hold back to economy.

So far, the picture is actually pretty simple. Temporary government restrictions on economic activity are in fact temporarily reducing that activity, but by little more than is absolutely necessary. When the restrictions end, the economy should be pretty much ready to go back to where it was before. 

There is one exception to this fairly satisfactory picture. As is so often the case, the financial system is in danger of poisoning the real economy that it is supposed to nourish.

Loans, leases and dividend policies are not designed for sudden economic stops. As the forced slowdown shrinks government, corporate and household cash flows, the originally agreed financial obligations become more onerous than either side intended. To avoid economically pointless bankruptcies and defaults, lenders and governments will need to recalibrate financial payments to match the unexpected reality of temporarily lower profits and incomes.

Fortunately, they learned something from the 2009 financial crisis: a malfunctioning financial system causes unnecessary economic damage. So governments are providing money to some borrowers, while regulators are encouraging lenders to be generous by not calling in old loans and making ample new ones to keep borrowers ready for better times.

Such radical financial moves are trickier to manage than subsidies for unemployed wage-earners. Simple cash distributions to keep borrowers afloat risk rewarding lenders who are generally already well off, so they can be politically toxic. Conversely, forced debt forgiveness sits very badly with affluent and politically powerful creditors.

Debt-heavy governments, companies and households could still sink what would otherwise be a smooth recovery. If that can be avoided, though, the health crisis need not become a lasting economic one.


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