Managing the crisis and planning for the day after

Managing the crisis and planning for the day after

The crisis that our world is passing through has challenged our institutions and our way of life in ways not seen for decades. Vibrant and welcoming cities have fallen silent; normally friendly and sociable people avoid each other. More fundamentally, the current crisis threatens a global depression just 13 years after the financial crisis and is straining the forces which unify the world in ways that no isolationist politician could ever achieve.

While policy responses may be context-specific, their ultimate direction should be the same: cushion the shock with fiscal expansion, take measures to reduce the persistence of the effects and follow up with a new social contract. This will combine reduced inequality and improved insurance together with a well-functioning market economy leading to better protection in the future and inclusive growth.

Immediate priorities

The brunt of the pandemic will be borne primarily by people in lower-paid jobs that require direct human interaction. The coronavirus has highlighted the vulnerability of this group – as well as its social importance. While many in tech and managerial jobs are able to take cover in their homes, nurses, supermarket workers and many manual workers have joined doctors on the front lines to take care of basic needs, including health and food supplies. Despite the risks, perhaps these are the lucky ones: They have work – many lower-paid jobs have simply disappeared.

The massive loss of jobs creates an immediate need for social support, with two goals in mind: preventing hardship for the unemployed and enabling a quick restart of the economy. While the US has responded with a large increase in unemployment insurance and small business loans with incentives to keep on workers, a more aggressive approach has been followed in the UK (and more recently Canada), where firms can furlough their workers while the government covers 80 percent of their pay. This ensures firms keep their workforce and are ready to start up again when the necessary restrictions are eventually lifted. Moreover, furloughed workers can find supplementary work – say in deliveries – without losing the right to government-funded payouts. This ensures a steady supply of workers to vital sectors of the economy, while at the same time shoring up the incomes of some of those most in need, at least for now.

To avoid a protracted recession and slow recovery, protecting businesses and mitigating the destruction of productive capacity must be a priority. The needs of small businesses likely differ from those of large companies, but all will need some form of support. Freezing rent and mortgage payments and supplying lines of credit backed up by the government are important ingredients. Frozen rents and mortgages can be capitalized and repaid in the future. We also need to ensure that delayed loan repayments do not destabilize the banking system. The approach by the US Federal Reserve of buying up corporate debt, including junk bonds, is likely to be an important source of liquidity. This is an example that the ECB should follow.

All this will create large funding requirements and will lead to debt levels we all feel uncomfortable with – and which, for countries like Greece, are unsustainable. This is not the time to hold back, however, because the destructive nature of the lockdowns will turn into a large permanent loss of wealth with persistent effects and terrible distributional consequences on the most vulnerable in society.

However, there are important practicalities we cannot ignore. The US can borrow effectively at no cost, even for longer-term debt. Countries like Greece and Italy are overindebted and any attempt to seriously ramp up their debt levels in response to the crisis could lead to large increases in their interest rates, if not total loss of confidence by the markets.

The EU should help in a number of ways. It has already allowed Greece the requisite fiscal space to increase borrowing. It should also issue Eurobonds to fund the crisis response The new debt burdens should be shared by all EU taxpayers. Indeed, if the EU and in particular the eurozone is to survive and become stronger, it has to introduce permanent institutions that allow insurance against external shocks that hit member-states unequally.

In the absence of exchange rate adjustments, fiscal transfers to smooth out shocks are an essential ingredient in a stable monetary union and can strengthen the argument for having the euro in the first place. Moreover, politically, such demonstrations of support can help neutralize extremist movements working to dismantle the EU. Of course such measures must be designed and presented appropriately to countries that will have to financially support their more vulnerable partners. Nevertheless, all need to be reminded that the Marshall Plan was just 70 years ago and Germany, for example, derives part of its strength today from being a beneficiary then. Misfortune, sometimes self-inflicted, can befall anyone. This is the opportunity for the EU to show it can internalize the impacts of shocks to individual members. Destroyed economies in the South will be to no one’s benefit.

Exit strategy

The lockdowns cannot continue until some distant point in time when a vaccine will be available. This would lead to economic catastrophe of biblical proportions. We will thus soon have to face the trade-off between minimizing the risks of infection and hospitalization, and allowing the economy to restart so as to avoid massive economic destruction, which could lead to destitution and even death for many.

The first step is a serious data collection exercise: mass testing, both for active cases as well as for antibodies showing past infection, to get a better picture of the transmission in the community and the number of people who have immunity. This will allow us to better handle the risks of lifting the restrictions, among other things, by linking return to work with some form of certification of immunity. We also need aggressive tracking of the inevitable new outbreaks to minimize the need for a reversion to a general lockdown. Such a strategy, with all its associated risks, needs to be clearly articulated so that households and business can plan ahead as best they can. The current uncertainty cannot continue.

The aftermath

At some point the acute crisis will end; but the task of building a society better able to withstand such massive shocks will remain as urgent as ever.

Debt will have to be one the first issues to be dealt with. And here we need to ensure that the most privileged in society bear the heaviest burden. Those of us now able to work from home, who can easily return to our former lives, must pay increased taxes. There are many ways this can be achieved, improving the tax system along the way. First off, we can broaden the tax base by ensuring that all sources of income, including capital gains and dividends, are taxed in an identical way to salaried income. Second, we will have to increase tax rates at the top of the income distribution. Third, we will also need to accept a general increase in taxation, including for the middle class, for the simple reason that this is where most of the tax revenue comes from.

Beyond immediate measures to improve public finances, we will also need a new social contract, which will offer a much stronger safety net. We may not be able to defy the laws of the market and increase pay across the board for lower-paid occupations, but we must accept that workers need to be properly insured and have access to high-quality healthcare and education for their children. In a post-crisis world, no life should be left defenseless, either against systemic crises or individual misfortune. A system with freely operating markets underpinned by genuinely high-quality social services, like those seen in some Scandinavian countries, can serve as the model.

A universal, taxable minimum income has been suggested as an important element of improved social protection. In work that we presented in our book “Beyond Austerity” (ed. Meghir, Christopher A. Pissarides, Dimitri Vayanos & Nikolaos Vettas), we simulated such a benefit for Greece and found such universal payouts must either be very small, in which case they provide little help, or very expensive, creating important work disincentives. To alleviate these concerns, we can use a tax credit – effectively a negative income tax on lower incomes – to improve support of the lower-paid while preserving work incentives. We can also introduce a stronger but contributory unemployment insurance system where people can build up benefits by contributing insurance premia and with benefits attached to the level of contributions, including suitable safeguards to avoid moral hazard. Improved healthcare and education can go a long way to improving social mobility. This approach is both redistributive and well-targeted without significantly distorting incentives to work.

These are difficult policy design questions. But the key point is that we need to reduce inequality and to admit that it reflects more than differences in merit but also failures of competition and of unequal opportunity in society: The poor for example get worse care and schooling for their children, which has long-run consequences on their ability to escape poverty. Inequality that arises from these structural failures can reduce innovation and growth. Policy has to reflect this and provide the necessary correction both by addressing the underlying problem and by being more redistributive.

The Covid-19 pandemic is revealing in stark colors the vulnerability of societies with weak state infrastructure and deficient social insurance. It also provides us the opportunity to make sure we are never this unprepared for such conditions again.

Costas Meghir is a Greek-British economist.

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