Author: Mohamed El-Erian
Source: The Guardian
Date: 30 Mar 2020
For years there has been a stubborn reluctance to adopt a more multidisciplinary approach
With the coronavirus devastating one economy after another, the economics profession – and thus the analytical underpinnings for sound policymaking and crisis management – is having to play catchup. Of particular concern are the economics of viral contagion, of fear and of “circuit breakers”. The more that economic thinking advances to meet changing realities, the better will be the analysis that informs the policy response.
That response is set to be both novel and inevitably costly. Governments and central banks are pursuing unprecedented measures to mitigate the global downturn, lest a now-certain global recession gives way to a depression (already an uncomfortably high risk). As they do, we will likely see a further erosion of the distinction between mainstream economics in advanced economies and in developing economies.
Such a change is sorely needed. With overwhelming evidence of massive declines in consumption and production across countries, analysts in advanced economies must reckon, first and foremost, with a phenomenon that was hitherto familiar only to fragile/failed states and communities devastated by natural disasters: an economic sudden stop, together with the cascade of devastation that can follow from it. They will then face other challenges that are more familiar to developing countries.
Consider the nature of the pandemic economy. Regardless of their desire to spend, consumers are unable to do so because they have been urged or ordered to stay at home. And regardless of their willingness to sell, stores cannot reach their customers and many are cut off from their suppliers.
The immediate priority, of course, is the public health response, which calls for physical distancing, self-isolation and other measures that are fundamentally inconsistent with how modern economies are wired. As a result, there has been a rapid contraction of economic activity (and therefore economic wellbeing).
As for the severity and duration of the coming recession, all will depend on the success of the health policy response, particularly on efforts to identify and contain the spread of the virus, treat the ill and enhance immunity. While waiting for progress on these three fronts, fear and uncertainty will deepen, with adverse implications for financial stability and prospects for economic recovery.
The risk that the financial system will reverse-infect the real economy and cause a depression is too big to ignore
When thrust out of our comfort zones in such a sudden and violent fashion, most of us will succumb to some degree of paralysis, overreaction or both. Our tendency to panic lends itself to still deeper economic disruptions. As liquidity constraints kick in, market participants rush to cash out, selling not only what is desirable to sell but whatever can feasibly be sold.
When this happens, the predictable result is high risk of wholesale financial liquidation, which, in the absence of smart emergency policy interventions, will threaten the functioning of markets. In the case of the current crisis, the risk that the financial system will reverse-infect the real economy and cause a depression is too big to ignore.
That brings us to the third analytical priority: the economics of circuit breakers. Here, the question is not just what emergency policy interventions can achieve but also what lies beyond their reach – and when.
To be sure, given that simultaneous economic and financial deleveraging would have disastrous implications for societal wellbeing, the current moment clearly demands a “whatever-it-takes”, “all-in” and “whole-of-government” policy approach. The immediate priority is to establish circuit breakers that can limit the scope of dangerous economic and financial feedback loops. This effort is being led by central banks but also involves fiscal authorities and others.
But there will be tricky trade-offs to navigate. For example, there is significant momentum behind proposals for cash transfers and interest-free lending to protect vulnerable segments of the population, keep companies afloat and safeguard strategic economic sectors. Rightly so. The idea is to minimise the risk that liquidity problems will become solvency problems. And yet, a cash- and loan-infusion programme will face immediate implementation challenges. Aside from the unintended consequences and collateral damage that come with all blanket measures, flooding the entire system in today’s crisis would require the creation of new distribution channels. The question of how to get cash to the intended recipients is not as straightforward as it seems.
There are even more difficulties when it comes to implementing direct bailout programmes, which have become increasingly likely. Far from being outliers, airlines, cruise lines and other severely affected sectors are leading indicators of what is yet to come. From multinational industrial companies to family restaurants and other small businesses, the line for government bailouts will be very long.
Without clearly stated principles as to why, how, when and under what terms government assistance will be offered, there is a high chance that the bailouts will be politicised, ill-designed and co-opted by special interests. That would undermine the exit strategies for putting firms back on their own feet and risk repeating the post-2008 experience, when the crisis was brought to heel but without laying the groundwork for strong, sustainable and inclusive growth thereafter.
Given how extensive government interventions are likely to be this time around, it is critical that policymakers also recognise the limits of their interventions. No tax rebate, low-interest loan or cheap mortgage refinancing will convince people to resume normal economic activity if they still fear for their own health. Besides, as long as the public health emphasis is on social distancing as a means of quashing community transmission, governments won’t want people venturing out anyway.
All the issues raised above are ripe for more economic research. In pursuing these avenues of inquiry, many researchers in advanced economies will find themselves inevitably rubbing up against development economics – from crisis management and market failures to overcoming adjustment fatigue and putting in place better foundations for structurally sound, sustainable and inclusive growth. Insofar as they adopt insights from both domains, economics will be better for it. Until recently, the profession has been far too resistant to eliminating artificial distinctions, let alone embracing a more multidisciplinary approach.
These self-imposed limits have persisted despite abundant evidence that, particularly since the early 2000s, advanced economies are saddled with structural and institutional impediments that have stifled growth in a manner quite familiar to developing economies. In the years since the global financial crisis in 2008, these problems have deepened political and societal divisions, undermined financial stability and made it more difficult to confront the unprecedented crisis that is now knocking down our door.
• Mohamed El-Erian is chief economic adviser at Allianz. He served as chair of President Barack Obama’s Global Development Council and is a former deputy director at the IMF