Covid-19 caught politicians, policymakers, and financial markets off guard. What happened since February 2020 has completely upset their risk calculation. The virus has disrupted health systems and the economy.
The overwhelming pressure of Covid-19 on the health system has crowded out regular Medicare. The fear of the virus has depressed aggregate demand by eroding business and consumer confidence. Mitigation and suppression measures have disrupted supply.
Often delayed, policy responses have been uneven over time and space. There have been missteps. Policy regrets are up. Animal spirits are down. Now, much further along the disease trajectory, the economic costs are higher.
Stringent mitigation measures, when enforced, have slowed the spread of the virus in many countries. The flattened curve of new infections is helping to reduce the stress on the capacity of health systems.
Governments across the world have to achieve the best possible outcome in protecting public health from the insidious virus while keeping the wheels of the economy running. This hardly has any precedent in the last hundred years. Policymakers have to synchronise and sequence a whole set of novel supply side interventions with conventional demand management policies.
The path of the shock and recovery is any one's guess – a wild, wild west for projections. The incompletely understood virus' properties could change. The true rates of infection and immunity are uncertain, especially where testing and tracing are limited. Second and third waves of infections is not just a possibility. Most countries, including the ones that acted relatively quickly, are still at risk as they nudge their economies back to work.
Any attempt at a definitive forecast is destined to fail. For the first time since 2002, China has not set a specific target for economic growth this year because of the great uncertainty regarding the pandemic and the world economic and trade environment.
The bigger scenario question revolves around the geometry (V, W, U and L) of economy's trajectory and structural legacies of the economic disruptions caused by the virus. A revival of confidence in the health system's capacity is expected to pave the way for a partial recovery in 2021 as the economic effects of the pandemic gradually fade.
Historically, global recovery has tended to follow recessions within a year. A subdued global recovery is currently envisioned over the next year – U rather than V. This recession is accompanied by financial turmoil and oil price collapses that can inflict lasting damage to potential output. The longer it takes to bring the pandemic under control, the deeper the global recession is likely to be.
Financial stress can drag recovery further. A prolonged Covid-19 crisis could drive up the number of real economy bankruptcies, making it harder for the financial system to manage. Meanwhile, a financial crisis would starve the real economy of credit.
Structural legacies are inescapable.
Economic disruptions are more severe in countries with larger domestic outbreaks; greater exposure to international spillovers; and larger pre-existing challenges such as informality. The pandemic is generally expected to exacerbate the ongoing weakness in private investment, which, combined with structural bottlenecks and fading demographic dividends, will inhibit productivity. According to the World Bank, investment declined by nearly 10 percent in five years in previous biological disasters, reflecting substantial risk aversion amid heightened economic uncertainty.
Unlike financial crises, decision on flattening the virus spread curve while minimising the disruptions to the economy is an uncharted territory for policy makers. They have to mediate the battle between the animal spirits and the virus until safe and efficacious vaccines and therapeutics give humanity the last laugh.
The stringency and duration of the suppression measures have remained controversial for understandable reasons. Harm reduction through interventions that limit the spread of disease without halting necessary livelihoods, such as hand washing, cloth masks and six-foot distance in public interfaces, are gaining currency because these are less disruptive. Reopening, contingent on social distancing and hygiene, is now the new game in every global neighbourhood amidst caution from epidemiologists and economists.
Overwhelmed in similar degrees, many countries are consciously or unconsciously adopting a herd immunity strategy. For herd immunity to work, the risk of the infected getting re-infected for a reasonably long period of time and the infected not suffering any permanent health damage will both have to be zero. This is necessary, but not sufficient. Sufficiency requires the benefits from reopening to exceed the cost of continuing the restrictive measures in high risk nodes until stronger health system capacity, vaccines and therapeutics come to the rescue. Any innovation that makes this problem tractable for the policymakers will deserve a joint Nobel Prize in the biological sciences and economics.
Aggregate demand has to be managed under deep uncertainties about how the dynamics on the supply side will evolve. The stress on livelihoods and financial markets has triggered a forceful monetary and fiscal response. Governments have adopted economic packages targeting households, firms, health systems and banks. While these measures vary across countries in breadth and scope, all countries have responded with expansionary macroeconomic policies.
Central banks across the world were the first responders on the macroeconomic front. The policies they have deployed reflect their own particular circumstances, mandates and legal structures. In general, monetary authorities are pushing commercial banks to lend to households and firms through interest rate incentives, liquidity support, forbearance in classifying the quality of loans and treatment of bad loans, suspension of debt service payments and a temporary easing of capital requirements. Quantitative easing through enhanced repos, purchases of private and public bonds and commercial papers are also used.
Fiscal policy has responded to the funding needs of the health sector, protecting critical public expenditure under declining revenues and supplying emergency relief to vulnerable populations and affected businesses. Specific measures include spending increases related to the health response, wage subsidies, transfer programs and expanded social safety nets, and various forms of tax relief for people and affected businesses. Governments are also providing support to commercial enterprises and financial institutions in the form of equity, loans or loan guarantees.
The pandemic has exposed the formidable challenges of widespread informality and financing constraints for small and medium enterprises in most economies. According to the International Labor Organization, over 2 billion workers depend on the informal economy globally in 2020, accounting for 62 percent of all those working worldwide. Informal employment constitutes 90 percent of total employment in low income, 67 percent in middle income and 18 percent in high income economies. Informal enterprises account for 8 out of every 10 enterprises in the world. Their low productivity, saving rates and capital accumulation make them highly vulnerable to shocks. They are often excluded by design or default from the Covid-19 related financial assistance programs for business enterprises.
Assessing the supply and demand response to different regimes of reopening and expansionary monetary and fiscal policies is crucial to determining the economy's trajectory. No matter how one tries, using the best calibrated scenarios that can possibly be conceived of, the conclusions remain sensitive to the assumptions about the key supply and demand side parameters until natural Random Control Trials unveil their true values. That will help historians while the rest will moan what could have been if these could be known before the fact.
Covid-19 policy experiences challenge the notion that policy conflicts can be temporarily suspended in times of crisis, with political opponents rallying around the proverbial flag until the worst is over. Societal situations where there is a threat to everyone, urgency to act, and uncertainty brings crucial leadership challenges. Response requires broad collaboration and coordination involving multiple individuals and organizations. Given heightened public attention and policy impacts across society, most policy actions or the failure to act are heavily scrutinized and politicized through framing contests and blame-games. Departures from such political business as usual have more been the exception than the rule.
Evidence-based policymaking has lost its initial lustre. The demand for scientific and technical expertise has surely increased as various communities and governments search for certainty in understanding the virus and choosing responses. However, Covid-19 has reaffirmed the concern of evidence-based policy advocates that political interests drive the use of evidence as well as counter-concerns about how scientific and technical experts also serve to inform, legitimize, and justify government responses dominated in reality by political considerations and normative orientations. Too often evidence-based policy turns into policy based evidence.
There are early signs that democracies and authoritarian regimes are amongst both the best and the worst performers. Francis Fukuyama has argued that whether a country is democratic, or authoritarian is not the primary dividing line when it comes to responding to the current crisis. What seems to matter more is the degree of state capacity and the ability of states to learn from previous outbreaks, the trust that citizens have in the state, and the role of political leadership in devising, communicating and guiding the implementation of a coherent and effective response.
The author is an economist.