Wednesday, March 25, 2020

Burn the old playbooks - Corona response proposal

Ananth and me have an article in Swarajya about an economic response plan to the Covid 19 pandemic.

The idea is to get ahead of the curve with measures, many of which we are most likely to anyways end up doing as the lockdown prolongs, but with diminished effect.

Consider the context.

Governments face unprecedented economic challenges on multiple fronts. Businesses cannot operate and workers have to isolate themselves at home. But businesses have to be kept solvent, and workers within the labour force. Further, purchasing power for basic necessities has to be supported, and their supply ensured. Furthermore, debtors have to be kept afloat without compromising on the interests of creditors.

The pandemic is a force majeure shock, triggered by non-business or non-economic decisions. Fundamentally, the costs of such shocks cannot be borne by private actors. Only governments can bear them. This is the critical difference between this, and earlier crises induced by economic shocks.

Liquidity support measures, either direct (credit window) or indirect (forbearance), cannot make up for the loss in output and wages due to the pandemic. Someone has to pick up that tab. They will have to be compensated, at least to a reasonable degree, failing which businesses have to close and workers starve. This is the fundamental reality. 

The Big Bazooka cannot be confined to financial market measures. Main Street needs to be bailed out, on both the supply and demand sides simultaneously.

Consider how the Pandemic has upended the normal rules of the game.

In the current circumstances, the lines between business solvency and liquidity have been blurred beyond distinction. After all, if a business shuts down for a couple of weeks, its liquidity dries up and can quickly turn insolvent. 

At a time when economic activities have come to a standstill, merely giving money to people is insufficient. For a start, business activity is facing a lockdown. Consumption decisions have been postponed indefinitely. New projects and investments are frozen not only for now, but for the foreseeable future too. As businesses are closed and people are confined to their houses, and economic activities come to a standstill, the velocity of circulation of money will crumble. 

Measures like tax breaks are unlikely to be effective, besides being a waste of scarce public resources. The beneficiaries of tax breaks are unlikely to be those badly affected, have lower elasticity of consumption, and are in any case unlikely to spend their disposable incomes in these uncertain times. 

And there are likely permanent damages. As businesses close down in large scale, they take down with it a vast associated economic eco-system. Workers exit the labour market and re-entry cannot always be assured. Entrenched economic relationships would have been deeply unsettled, even destroyed. Recovery from this can be very long drawn and painful since re-adjustments can be sticky. 

Even the assessments of the human cognitive biases that underpin financial market transactions have to undergo change. Moral hazard concerns may have to be placed under suspended animation for some time. In case of measures aimed at directly supporting the Main Street, this is not the time to fuss excessively about incentive distortions.

Update 1 (26.03.2020)

More detailed proposals from Vijay Mahajan here, Vivek Kaul here.

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