New trends and possibilities post-Covid 19

By the time Covid 19 is behind us, several things would have changed in the world economy. Here is a list of a fourteen intriguing possibilities. I will keep updating this.

1. The massive rescue packages announced by national governments mean that the remorseless accumulation of debt that has been a feature of the world economy since the early eighties may be about to enter a new phase of acceleration. As with many trends in the world economy, Japan again may be the pointer.

Tokyo has run large fiscal deficits for decades and seen its debt balloon to 240 per cent of economic output, but continues to enjoy some of the lowest borrowing costs in the world. That is largely because the Bank of Japan has gone further than other central banks, buying as much debt as it needs to keep yields below certain thresholds under a policy known as “yield curve control”. Yields on 10-year Japanese government bonds (JGBs) have steadily fallen from nearly 2 per cent in 2006 to less than 0.02 per cent today. The futile trade of betting against the bonds has been dubbed “the widow-maker”.

The FT article points to the Fed being ready to set out on its tryst with "yield curve control".

2. As both the stock and flow of debt mounts, governments in the developed world will grapple with the issue of avenues to mobilise resources. If its advocates can push the agenda on it, with a bit of luck, higher marginal tax rates on the richest will become a reality. The moment has never been riper on this. Thomas Piketty's suggestions will no longer look fanciful.

The example of World War II when taxes surged to finance the war effort is a case in point. Morgan Hausel quotes FDR from 1942,

Are you a businessman, or do you own stock in a business corporation? Well, your profits are going to be cut down to a reasonably low level by taxation. Your income will be subject to higher taxes. Indeed in these days, when every available dollar should go to the war effort, I do not think that any American citizen should have a net income in excess of $25,000 per year after payment of taxes [roughly $375,000 adjusted for inflation].

Emmanuel Saez and Gabriel Zucman call for an excess profit tax,

The government should impose excess profits taxes, as it has done several times in the past during periods of crisis. In 1918, all profits made by corporations above and beyond an 8 percent rate of return on their capital were deemed abnormal, and abnormal profits were taxed at progressive rates of up to 80 percent. Similar taxes on excessive profits were applied during World War II and the Korean War. These taxes all had one goal — making sure that no one could benefit outrageously from a situation in which the masses suffered.

The excess profits tax is something which makes great sense. After all a world-wide force majeure event applies just as much to Amazon as it does to Delta Airways. And Amazon has not done anything to deserve the current business growth and post-pandemic head start that it would stand to benefit from. 

3. For governments struggling to bridge fiscal deficits, as Andy Mukherjee writes, another avenue can be to ease out the favourable treatment accorded to debt over equity. Apart from raising additional revenues, this would also serve the purpose of throwing sand on the wheels of corporate debt accumulation, which has worsened the crisis. The debt bias is for real.

For historical reference, the tax exemption on interest expenses was supposed to have been a temporary measure,

It was in 1918, when economists were likening the global spread of an excess profit tax on wartime corporate income to the deadly outbreak of the Spanish flu, that the U.S. relented and allowed all interest paid to be deducted from taxable profit. It was a temporary measure to give firms relief, but although the extra tax burden went away in 1921, the favorable treatment of interest income stayed and was copied around the world.

He writes about a 100-year opportunity for reform on tax deduction on debt expenses, 

The additional corporate value garnered with cheap debt isn’t a free lunch. An International Monetary Fund staff discussion note warned in 2011 that “costs to public welfare are larger — possibly much larger — than previously thought.” The 2017 overhaul of the U.S. tax code restricted interest deduction to 30% of earnings before interest, tax, depreciation and amortization as an offset for slashing the corporate rate to 21% from 35%. The U.K., too, put a limit... With industries of all hues begging governments for survival capital, rebates and even employee wages, bargaining power of firms is at rock bottom. The unfinished tax reform agenda has a chance. Given that suppliers of debt financing are spread all over the world, a withholding tax on interest payments could cause dislocations. “A less disruptive option,” as law professors Michael Graetz and Alvin Warren, Jr. argued in a 2016 essay, “might be to deny deductions for all or part of interest payments at the corporate level.” 

A post-coved work which at least partially removes the preferential treatment accorded to debt could be a step in the right direction.

Robert Armstrong in FT too agrees.

4. In response to the UK Government's latest £60 bn rescue package announcement, which would have widened its fiscal deficit to over £200 bn, the rating agency Fitch  downgraded the country by a notch to AA-.

In the coming days, rating agencies will in all likelihood be forced to recalibrate their models, as every country in the world undergoes an unprecedented simultaneous steep recession coupled with a steep increase in fiscal spending to mitigate the downturn.

This could turn out to be a blessing in disguise for countries like India as it weighs its own fiscal deficit options.

5. Most countries started the pandemic with weak economies and an already high debt burden. This will only worsen significantly due to the rescue packages announced. This creates a dilemma.

On the one hand, with debt burdens soaring (estimated to reach 130-140% of GDP in US against 120% reached after WW II), governments and central banks will be keen to keep rates low so as to prevent debt sustainability problems. Low rates, already a feature over the last decade, will have to get further entrenched as the new normal. But this demands continuation of the current extraordinary monetary policy actions for a long period of time, for the foreseeable future.

Central banks will have to navigate completely uncharted waters, with all the unpredictabilities and uncertainties. The consequent accumulation of distortions will not come without costs, and huge ones at that, down the future. As the Economist writes, it could have laid the path towards revival of inflation.

The crisis could weaken structural forces weighing on demand. Take inequality, for instance, which concentrates income in the hands of the thrifty rich. More generous post-pandemic safety-nets, or progressive taxes enacted to pay down large government debts, could redirect income towards freer spenders, creating inflationary pressure. So could a change in policymaking attitudes. The economic traumas of the early 21st century may push governments and central banks to prefer high economic growth and low unemployment to low and stable inflation, as happened after the second world war. Inflation is not certain to return after covid-19. But its re-emergence seems less fantastic a possibility.

6. An interesting thing about the crisis has been sheer scale of economic policy responses in the US by both the Federal Reserve and the Treasury. Both have accredited themselves with the most far-reaching measures upfront in response to the emerging crisis, measures which dwarf those during the 2008 crisis. Interestingly, those at the helm were acclaimed for their actions then and latter. It has since often been held out as an example of how experts could be trusted to address such crises.

In contrast today, Jerome Powell who heads the Fed is a lawyer. And President Trump's Treasury has long been accused of not having or heeding star economists. But their performance, at least till date and to the extent of the rescue measures announced, has been truly impressive. Will the likes of Steve Mnuchin and Jerome Powell be acclaimed by the same people who have written that Lloyd Blankfein, Tim Geithner and Ben Bernanke "saved the world"?

Gillian Tett has glowing praise for Jerome Powell,

When he was named chairman of the US Federal Reserve two years ago, some observers, me included, suspected he might be distinctly dull. Unlike his immediate predecessors, Mr Powell was no economics luminary; nor was he much of a performer, or “maestro”, as author Bob Woodward dubbed Alan Greenspan. Mr Powell had forged most of his career in the camera-shy world of corporate law. Colleagues described him as “pragmatic”, “self-effacing”, “genial”, “humble” and “cautious”. However, Mr Powell is fast becoming the least cautious — or dull — Fed chair in history. As the coronavirus pandemic shuttered the global economy, he scrambled to deploy and build on tools created by his predecessors to fight the 2008 crisis: cutting rates, buying Treasury and mortgage bonds and supporting the commercial paper market. Now the Fed is moving into new territory: it has pledged to purchase municipal and corporate bonds, along with exchange traded funds, and organise a so-called Main Street bank-lending programme for the first time. Mr Powell is not just crossing traditional red lines, but deliberately sprinting over them... In one area, Fed officials have already scored a huge success: they narrowly averted a market meltdown last month. As historian Adam Tooze tweeted, they “flattened the curve” of the initial coronavirus financial panic. The scale of this achievement is outlined in a new Bank for International Settlements report. It describes in chilling detail how much stress was created when leveraged hedge funds stampeded for the exit in the Treasury market and threatened to create cascading shocks. That Treasury prices are now relatively stable is a big victory. So is the easing of conditions in the municipal, corporate and mortgage markets.

A healthy recalibration away from individuals and experts is much needed. However, I am not very sure this can become a trend.

7. Whatever the support measures from governments, the Pandemic will leave a landscape filled with distressed businesses. Besides valuations would have been shattered - in March 2020 alone the 500 biggest public companies in the US lost $3 trillion in valuation. These are great conditions for distressed asset buyers and private equity. Sitting on over a trillion dollar of raw powder, private equity firms, especially the top tier ones, will be in pole position to benefit from the Pandemic. Similarly, hedge fund giants too have started mobilising funds to be ready to invest when the market hits bottom.

On the other hand, any removal of the debt bias will remove the ingredient that alternative investment funds use to juice up their returns, thereby weakening their prospects.

8. Globalisation, already under assault from protectionist trends, will become more defensive. The Covid 19 Pandemic may have hastened slowbalisation, atleast for the medium-term. Sample this and this for just two articles on the bleak prospects for globalisation.

Nowhere is this protectionism more evident in medical supplies. The Global Trade Alert project at the University of St Gallen in Switzerland says that at least 69 countries ave banned or restricted the export of protective equipment, medical devices or medicines. 

9. The lockdowns will provide a big boost to online activities of all kinds. In education personalised learning instruction through adaptive learning softwares will invariably improve and become common. Similarly telemedicine technologies will be expedited. Tools to make remote work more practical and effective will emerge and hasten the 'work from homes' trend.

10. One of the most critical legacies of the pandemic may be on the area of digital data privacy. In the quest for quick-fix solutions to enforce lockdowns, private information about patients have been shared on the media and doctor-patient confidentiality has been breached. The Economist writes that the data tools being used to fight Covid 19 may provide the slippery slope for erosion of privacy in the guise of collective good.

11. One of the biggest shifts could be with attitudes towards the government, especially in relation to the private sector. The stimulus measures, sovereign debt, expansion of welfare state, and surveillance are only some of the reasons for the return of the big government.

12. On the positive side, Covid 19 may have brought down the curtain on the era that Ronald Reagan inaugurated with his  derisive caricature of the government, pointing to the most scariest thing in the world - “I’m from the government and I’m here to help”!

For example, no UK government can now afford to not strengthen and build on the NHS for the foreseeable future.

This is just as much relevant for opinion makers and researchers on development. For those advocating private sector, cash transfers and other innovations to deliver public services, the pandemic should be a cautionary note. The public distribution system, primary health care facilities and their field personnel, panchayat administration, ICDS centres etc have been at the frontlines of the crisis fighting. 

13. One of the features of the modern economy is the emergence of large integrated networks or systems of economic activity. So we have large chains in retail, healthcare, education, hospitality, and so on which have displaced the small, owner-operated, and stand-alone establishments. But while the former is economically more efficient, it also comes up with its set of concentrated risks, which become so evident in times of such pandemics.

Sample this about India's kirana shops compared to e-commerce establishments,

Despite significant growth in e-commerce’s reach and sales during the Covid-19 crisis, the local kirana stores have emerged winners. The traditional trade channel that serves over 1.3 billion people, compared to some 120 million by e-commerce, has fared significantly better when it comes to availability of essential goods like rice, wheat, pulses, milk, sugar and salt. Obstacles faced by delivery personnels during the initial days of the lockdown might have played a key role in its poor service and a sudden dip in availability of essential items on online channels also impacted many.

Both policy makers and businesses will have to give greater weightage to the issue of risk management and resilience in the trade-off with economic efficiency and profitability.

See also this on the resurgence of kirana shops from NAR.

The struggles faced by Amazon's famed supply-chain management system is now widely acknowledged.

14. Finally, the pandemic may be the tipping point for efforts to end the regulatory arbitrage enjoyed by internet companies, especially the independent contractor status of the employees of sharing economy companies. Out of their jobs and without any economic safety net, they have been among the worst affected by the pandemic.

Update 1 (11.05.2020)

Arun Maira lays down seven principles for a new order - reduce the obsession with GDP growth; resurrecting boundaries between nations; government is good; market is not the best solution; citizen and not consumer welfare should be the objective of progress; competition must be restrained; intellectual property belongs to the public.