Economic physiotherapy

No, the worst of the crisis is not yet to come. We soccer players know that the recovery after the dreaded rupture of the knee’s anterior cruciate ligament can be very long, but the worst moment is when you tore it, the sharp pain, the realization that your life is going to change for a long while, the fear that you may never regain your previous power and speed. Physiotherapy is slow, tedious and long, but the daily progress shows the light at the end of the tunnel.

The economy is now entering that physiotherapy process. The worst is over, the initial fear of an invisible and novel virus, the sudden disappearance of customers, the overnight spike in unemployment, the emptying of the streets. In these months we have learned to better manage the virus and mitigate its effects. The economy has been brought back to life again. Of course, success will depend on managing the recovery well, there is no room for excuses or complacency. From now on, if economic policy is adequate, if all the necessary resources are provided, if the relapses of the pandemic are well managed, the process of improvement will continue, weathering the storm until the medical solutions allow restrictions to be removed.

If the public sector assumes more risk, in an intelligent way, the economy recovers faster and better, and total vulnerability decreases

It is also the time to reflect on the lessons learned. One of the keys to crisis management is getting the diagnosis right. Fortunately, the initial temptation to define this crisis as a supply problem in the face of which monetary and fiscal policy could do little quickly disappeared. Defining this crisis as an induced economic coma, and not a recession, has allowed for the adoption of a different strategy. The concern with moral hazard has been set aside, and two simple but effective rules have been adopted as a general principle of action – unconditional support (graduated by sector according to restrictions) for incomes, employment and liquidity while restrictions are in place, and an expansionary fiscal policy until the 2019 gross domestic product (GDP) levels are restored. Policy coherence will be critical: let’s not forget the outsized negative impact of the 2014 tax hike in Japan.

This new strategy will avoid a repetition of the aftermath of the 2007 crisis. The obsession with reducing the deficit and debt at all costs has been put on hold, placing the emphasis on activating the fastest possible recovery. It is the paradox of risk taken to its maximum expression: if the public sector assumes more risk, in an intelligent way, the economy recovers faster and better, and total vulnerability decreases.

In a typical recession, it may make sense to encourage the rapid reallocation of resources and the fast liquidation of insolvent companies. In an induced economic coma the recipe is the opposite, the life of the productive fabric must be prolonged until the necessary restrictions are eliminated, normality is restored, and the market can perform its triaging role. The public sector has to act as the investor of last resort, and be willing to assume the risk of losses to ensure that the temporary lack of liquidity of the private sector doesn’t turn into insolvency. It is the public sector fulfilling its traditional role of insurer of last resort in the face of a systemic shock.

That is why several European countries have already decided to extend the short term work schemes until 2021. That is why, in the United States, there are proposals to graduate the amount of unemployment benefits in proportion to the unemployment rate – the higher the unemployment, the higher the amount. Empirical evidence in the US shows that the recent increase in unemployment benefits has not altered incentives to seek employment. Workers, logically, prefer stable employment to improved unemployment benefits, as employment reduces uncertainty.

The period of physiotherapy should also be used to increase strength and resilience

This crisis has given another twist to the dilemma between efficiency and resilience. There is no doubt that improving efficiency through, for example, market liberalization, globalization, or offshoring, is the key to increasing productivity. But the 2007 crisis already gave a first warning about the need to balance efficiency and resilience in the financial sector. The Fukushima disaster in 2011 sharpened the focus on the risks of offshoring and global production chains. There is mounting empirical evidence showing that predistribution increases stability and, therefore, efficiency. Covid-19 has suddenly awakened health nationalism – remember the initial restrictions on masks exports. The precariousness and lack of capacity of some hospital systems indicates that, in some countries, the search for efficiency in healthcare spending had perhaps been taken too far. But beware of using resilience as an argument to protect, in a populist and inefficient way, certain sectors. Industrial policy is a dangerous double-edged sword.

The period of physiotherapy should also be used to increase strength and resilience. The context could not be better: with inflation and interest rates at very low levels, and the historic opportunity of the European reconstruction plan, it is the time to reduce unemployment as quickly as possible and to adopt measures to increase potential growth, mitigate the impact of climate change and reduce inequality. It is the moment to be ambitious and think big.

@angelubide