Simons Blog: Why this crisis will bring about a new economic settlement
Policymakers reverted to the status quo after the last recession. This time must be different.
PUBLISHED26. MARCH 2020
READING TIME5 MIN
Western governments were slow to appreciate the risks of coronavirus. This was mainly because they were complacent about the chances of it really taking hold beyond East Asia, believing it to be largely a repeat of the 2008 Sars outbreak. Even once the scale of the Italian lockdown was apparent, major investment banks were forecasting relatively shallow recessions in Europe and the US, followed by a rapid bounce-back. All that has now changed. It is clear that Europe and the US face unprecedented recessions: estimates vary but economies could easily contract by 20 per cent between April and June. And there is considerable uncertainty over the timing and strength of the rebound. This has prompted a huge fiscal response, including unparalleled support for firms and households and aggressive action by central banks.
For some, the scale the current crisis and the centrality of the state to combating it makes a return to the small state, free market status quo of the last 40 years impossible. They argue the crisis has demonstrated that the state ultimately underwrites the whole of the private sector and shown that rules are not set in stone; things that were considered impossibilities prior to the crisis have quickly become realities. Some economic liberals are alive to the risks in all this, with the likes of Arthur Laffer (of “Laffer curve” fame) and Stephen Moore arguing that crisis measures by governments to support households could discourage people from working. Others argue that the cure risks being worse than the disease.
Will the crisis discredit a whole way of thinking, by demonstrating that the state is not an obstacle to economic resilience but the indispensable guarantor of it?
Or are we destined to repeat the mistakes of the financial crisis, when governments failed to draw the obvious lessons? Much will depend on the depth of the crisis and the speed of the bounce-back. But there are reasons to believe that this time things will be different.
The first reason why change now looks inevitable is the 2008-09 financial crisis itself. The bailout of the financial sector, and the subsequent return to business as usual combined with austerity after the crisis, was one reason for the erosion of trust in governments and elites and the rise of populist forces in the US, UK and elsewhere in Europe. Massive state support for business and then a return to business-driven policies would be politically risky this time round. And the longer the private sector needs unprecedented state support, the harder it will be for economic liberals and the finance sector to engineer a return to the previous state of affairs.
Even conservatives—in Europe at least, if not in the US—appreciate this. Rewriting history will be harder than it was after the financial crisis, when some bankers quickly moved to distract from the damage they had done to our economies and the cost of bailing them out by championing austerity and aggressive moves to reduce the size of the state. Those arguing the same this time round risk being left stranded as the tide goes out; such chutzpah was already wearing thin. Privatised profits and socialised losses will be a tough sell politically.
The second reason is that the economic bounce-back will in all likelihood be less rapid than many are hoping: it is unlikely that the economies can be placed in a temporary coma and then brought back to full health once the virus is beaten, without lasting damage. The underlying strength of economies will no doubt be impaired, perhaps seriously so, requiring high levels of state support for some time to come.
Of course, some of the crisis-fighting strategies now being employed by European countries—such as wage subsidies—have been used before, and governments have run big fiscal deficits only for economic orthodoxy to reassert itself quickly once the immediate crisis passed.
But the scale of the current measures goes well beyond the measures employed in previous crises.
Governments are likely to end up controlling sizeable chunks of the private sector, whether through nationalisations or direct equity stakes. And much of the rest will owe its survival to government support of one form or another.
The third reason is that countries with activist states and comprehensive welfare systems are likely to come through the crisis better than those without them. For example, assuming the eurozone can do enough to prevent a sovereign debt crisis in Italy (a big assumption, admittedly), Europe is likely to fare better than the US, which could face serious social instability unless the Trump administration does much more to support households. Not only is the exceptional support for households and businesses by European governments likely to mean that the recession is shallower in Europe than in the US, but the crisis is also likely to demonstrate the indispensability of well-funded, universal healthcare systems and the power of automatic stabilisers such as generous welfare and sick-pay entitlements.
The fourth reason is that governments will simply not be able to risk a repeat of this crisis; the economic and political costs would be too high. This means building economic resilience to risks. Obviously, this will involve better preparation for pandemics themselves but also less systemic risk as a whole. Governments are unlikely to tolerate the current degree of corporate borrowing and the threat this poses to the broader economy. They will be keen to avoid the spectre of bailed out firms continuing to receive tax relief on debt used to buy their own shares and then to pay out inflated dividends. Governments might consider they have no option but to limit financial intermediation more generally by reducing the implicit government subsidies that drive it. And they will almost certainly put in place contingency plans for the most likely climate risks and the dislocation they could cause.
The final reason is that the balance between globalisation and national autonomy will inevitably shift. Governments will have little option but to place greater emphasis on national self-sufficiency, especially in regard to healthcare and food supplies, but also on the maintenance of manufacturing and technological competences needed to bolster countries’ resilience to crisis. This is likely to extend to governments placing greater importance on national ownership and control of such assets. The recent moves by various European governments to block foreign takeovers of firms are unlikely to prove temporary, forcing reform of EU competition rules. Eurozone governments will also no doubt fight hard to retain the greater fiscal freedom they have gained during the crisis.
Change seems inevitable. The question is whether it will be benign or malign. The possible policy shifts outlined in this piece could bolster economic and social stability. And a better balance between globalisation and the nation state could strengthen multilateralism, as was the case under the Bretton Woods agreement in the post-war period. It is therefore essential that progressives and moderate conservatives attempt to bring about a new settlement. Otherwise, they risk opening the way for right wing-populists and a period of damaging beggar-thy-neighbour economic nationalism.
This article was first published on Prospect Magazine: Will this crisis bring about a new economic settlement?