Coronavirus has created a rollercoaster economy riddled with pits and troughs. So how can we stay on the right track? Dr Simon Ashby of Vlerick Business School has some ideas
My wife and I are relative newcomers to Brussels, and last autumn we visited a nearby theme park as part of a Vlerick Business School family fun day. We had no idea what to expect, but we knew that neither of us are fond of rollercoasters. Nevertheless, surrounded by friendly colleagues, we found ourselves trying out some of the less extreme rides. At least we could see that they were not too scary. Now, imagine that you are an economic policymaker in Europe and, like us you are not a big fan of rollercoasters either – at least not the economic kind. Worse still, you are now stuck on the ride blindfolded, with no idea how far you will fall or how long the ride will last.
Before the Covid-19 pandemic the global and European economic outlook appeared calm. More family fun than white-knuckle ride. In Europe, growth was expected to be modest, but stable. Countries like Italy, Greece and Spain all appeared stronger than they had been since the 2008 financial crisis. Even until early March the economic impact of Covid-19 was expected to be short-lived. This is called a V-shaped recovery. A short fall, with a quick return to the previous state of economic affairs.
At the present time, the prospect of a quick V-shaped recovery looks much less likely. On the 8 June, the World Bank predicted that global economic output (GDP) in 2020 will fall by 5.2%, with many emerging economies like Brazil and India facing their first recession for 60 years. The eurozone could be hit even harder, with up to a 9.1% contraction. As a result, most economists are talking about a much slower U-shaped recovery, or even worse, one that is L-shaped – a very steep, almost vertical drop, followed by a long period of economic stagnation. Not even the most ardent theme park thrill-seeker would trade such a drop for the sustained absence of “fun”.
Currently there are too many uncertainties to be confident about the precise nature of the economic recovery. Worse, many of the questions that need to be answered to resolve this uncertainty are not economic in nature. Will there be a second wave of infections? Will strict lockdowns have to be imposed yet again? Can a vaccine be developed, and if so, how soon? These are questions for medical researchers and epidemiologists, but the decisions that politicians make based on the advice provided by medical science will continue to have deep and long-lasting economic consequences.
What then can economic policymakers do? Besides hold on and hope that the ride is over soon. Already they have done much to cushion the economic blow of the pandemic, including cutting interest rates, increased quantitative easing to maintain financial market liquidity and a range of other measures including low cost business finance, grants and wage replacement schemes for the temporarily unemployed. But there is more to do in order climb back up from the trough of our economic rollercoaster.
Not the time for austerity
The last time that central banks and governments borrowed large amounts of money to pump into their economies was during the financial crisis of 2007-08. The costs of these necessary actions were considerable, and many European countries were hit especially hard, triggering sovereign debt crises in countries such as Greece, Italy, Ireland, and Spain.
To help repay the cost of these stimulus measures, a policy of economic austerity became a dominant theme in many European countries. The aim was to repay the money as soon as possible. The logic being that as soon as a crisis is over, and the piggy bank is empty, it should be refilled quickly, because you never know when it might be needed again.
What if you do not have sufficient spare funds to fill your piggy bank? What if businesses and households have been hit so hard they cannot afford to invest or spend to stimulate a recovery? The only answer then is to cut back on government spending, often by a substantial degree. This refills the piggy bank, but such cuts can have severe social and economic consequences. Across Europe economic growth remained slow for over a decade and many people suffered financial hardship, even poverty, as a result.
The problem with austerity is that the cure can be worse than the disease and the last thing we need is more of the same. However, there is an alternative, to increase fiscal stimulus (e.g. cuts to VAT, low cost business loans, etc.) and encourage businesses and consumers to spend their way into economic growth and, of course, increased tax revenues.
True there are risks associated with this strategy. No government can borrow money indefinitely. Sooner or later its credit rating will suffer, it may struggle to meet the interest payments and creditors may decline to provide funds. But the debt headroom that governments can enjoy today is far greater than in 2008. Interest rates remain at historic lows and are even negative for highly rated sovereign debt, meaning that creditors are paying countries like Germany, Belgium, and Switzerland for the privilege of lending them money. Equally almost every country around the world has been hit hard by the pandemic, meaning that most nations have had to increase their national debt. After the Global Financial Crisis there were clear outliers (Italy, Greece, etc.), now every nation is facing the same fiscal challenges.
Increase taxation, but tax who?
It will be hard to escape increased taxation, especially if this is used to protect the incomes of the vulnerable, improve healthcare or support business investment. But who should be taxed?
People on low incomes have suffered very badly during the pandemic. Because of their low wages they have little or no savings to fall back on. Plus have more fixed costs like rent or loans, making it harder for them to economise. Therefore, it does not seem fair that they should face higher taxes in the future. They need time to recover and rebuild their lives. This is also good for economies, after all those on low incomes make up a big percentage of consumers and through their spending they will support growth.
One solution is to raise corporation tax, especially for large corporates. Or at least pursue these companies for the tax that they owe. Three sectors tipped to do well in the wake of the pandemic are technology, online retail, and medical research and manufacturing. Large essential retailers, like ™ supermarkets, have also performed well. If these profit windfalls relate to the pandemic, it only seems right that these corporations should contribute towards the economic costs. Of course, getting large, multinational corporates to pay their ‘fair share’ of tax is never easy, but I hope that the pandemic will provide fresh political stimulus.
Another is to tax wealth. As a homeowner with savings this is a prospect that I dread. But from an economic perspective it makes sense. The wealthy save their money and though these savings are often invested, the economic stimulus this provides is much less than that of direct consumption. Businesses will not expand, even if cheap funds are available, if there is insufficient demand for their goods and services. Equally, the heavily regulated financial institutions like banks, which look after these savings, are often restricted from lending to business start-ups and small to medium sized enterprises looking to expand, because they are considered overly risky. The more wealth we can release into economies, the better, if we are to stimulate the quickest possible recovery.
I believe that European policy makers need to stick together. The German Constitutional Court ruling that the ECB should be asked to justify its economic stimulus measures is a cause for concern in this regard. As, unfortunately, a British national I am all too aware of some people’s desire to “take back control” from Brussels, especially when they dislike how their hard-earned money is spent. The problem is that pandemics do not respect artificial national borders. Neither do financial markets and international investment flows.
The best way to grow our pan-European economy post pandemic is to do it together. This may well include more fiscal stimulus via the ECB and increased regional funding via the EU. Inevitably this will have a cost for member states, but we must remember that, if the money is spent correctly, the returns, in terms of future economic growth may be considerable. We should also explore alternative methods of finance, like pandemic bonds: a form of insurance, that can be used to help pay for pandemic events. The World Bank has already used funds from such a bond to support its response. Financial markets have a voracious appetite for return, so why not gamble on the potential for future pandemics? If none occur pandemic bond purchasers can enjoy good returns, but if another pandemic does happen then there will be much needed funds to support the recovery.
Thinking back to our family fun day, having friends and colleagues around us gave us the courage to ride the rollercoaster. I hope that we can achieve the same result while riding the economic rollercoaster of the next few years. The more we cooperate the more we can stay on the right on track and return to business as usual, with its more familiar ups and downs.