Unprecedented havoc needs unorthodox remedies
The upheaval Covid-19 is causing in people’s lives around the world is wreaking even greater havoc in the global economy. The impact will be far larger than the damage caused by the Global Financial Crisis. The remedies will have to be much faster and even more unorthodox, ambitious and far-reaching, says Rod Oram.
Quite simply, the Covid-19 virus is causing a dramatic slowdown in the perpetual money machine which is the global economy. Incomes enable people to consume, which stimulates production, which generates income for more consumption – a money-go-round generating some $150 trillion a year in global GDP.
The GFC was only a breakdown in the financial system, the lubricant of the economic machine. Nonetheless, it took Herculean efforts by central banks and governments to fix the system; and austerity measures and other tools caused collateral damage to economies and societies.
The GFC caused only a brief drop in global GDP, although some countries, mainly European, suffered more. Even so, between 2008 and 2010, government debt of the Group of 7 large economies rose by 10 to 25 percentage points as a share of gross domestic product. Government deficits worsened by four to 10 percentage points. Much of that was caused by lower GDP, which reduced tax revenues and increased spending on unemployment benefits and other measures. Fiscal stimulus was a far smaller cost.
... even the shortest, easiest disruption is still far greater than the conventional economy, aided by conventional remedies, can endure without significant damage.
This pandemic, though, is causing the economic machine itself to falter. The Chinese economy is thought to have contracted by some 13 percent in the first two months of this year; JP Morgan’s latest forecast is for a 16 percent contraction in the US economy this year; and unemployment could reach 20 percent in the US and Europe.
The first shockwaves have hit here. On Monday, Auckland Airport served 44 percent fewer international passengers than it did on the same day last year. In the week to Monday, international passengers were down 25 percent; Air New Zealand’s revenues this year could plunge from $6 billion to $1b, according to its most pessimistic scenario; and the NZ Hotel Owners Association says its members could lay off some 40 percent of their staff because of plummeting occupancy rates.
Nobody in the world knows how long and severe lockdowns will have to be to stifle the virus and to buy time to develop a vaccine and distributed it widely. But even the shortest, easiest disruption is still far greater than the conventional economy, aided by conventional remedies, can endure without significant damage.
As Pierre-Olivier Gourinchas, an economics professor at the University of California, Berkeley, points out, if virus containment measures reduce economic activity to half its normal level for just one month, and then to three-quarters for two more months, year-on-year growth will fall by 10 percent.
Our economy, like those of other developed countries, is largely driven by its service sectors -- such as retail, wholesale, distribution, hospitality, travel and entertainment – rather than their manufacturing sectors. But we’re even more vulnerable because of our large international tourism sector, which until the virus hit was our biggest earner of foreign exchange.
Only deeply unorthodox remedies, rapidly applied, would work
Our Government has announced $12b of measures in its first support package for the faltering economy. For example, wage subsidies will help small companies keep people employed. But they need to be for all companies, and to be closer to actual wage levels to minimise the drop in consumption.
The next step must a Universal Basic Income, as Bernard Hickey argues for in this companion economic piece on our Newsroom website.
But that would still fall far short of filling the gaping financial hole companies will suffer from a steep drop in economic activity. Only deeply unorthodox remedies, rapidly applied, would work. Here are two which have surfaced already in the US:
- The US government should step in as payers of last resort, argue Emmanuel Saez and Gabriel Zucman, economics professors at the University of California, Berkeley. The payments would cover wage and maintenance costs for businesses facing shutdown. This would be “a new form of social insurance, one that directly helps both workers and businesses.”
Their analysis of the US economy suggests that a nationwide lockdown would cause a 30 percent drop in economic activity in the US over the next three months, leading to a 7.5 percent drop in annual GDP.
But if the government compensated companies for 60 percent of their labour costs and half their operating costs (the latter would be down from pre-crisis levels because of reduced activity), the cost would be about 3.75 percent of GDP, financed by an increase in public debt.
The programme would be limited to three months, assuming the worst of the epidemic was over by then. With damage to employment and capacity reduced, the economy would rebound far faster, resulting in a greater pick up in government tax revenues.
“The direct output loss from social distancing measures would in effect be put on the government’s tab, i.e. socialised,” they write.
- Alternatively, the US government should offer every American business, large and small, and all self-employed people a no-interest “bridge loan” guaranteed for the crisis and repayable after over five years, proposes Andrew Sorkin, one of the New York Times’ leading business journalists.
The only condition is that they employ at least 90 percent of the workforce and at the same wage they did before the pandemic. He also proposes that companies’ existing banks administer the programme since they already know their customers.
His rough estimate of the volume of loans, assuming a three-month peak to the crisis, is US$10 trillion, equivalent to about half the US GDP. Assuming 20 percent of the loans wouldn’t be repaid because of business failures or avoidance, the cost to US taxpayers would be well over US$1 trillion.
“But with interest rates near zero, there is no better time to borrow against the fundamental strength of the US economy, spend the money and prevent years of economic damage that would ultimately be far, far costlier.
“The alternatives being proposed may be worse — because the size of the bailouts may be too small and come too late, and because the politics of targeted bailouts at specific industries and businesses would create a morass of anger and distrust.”
The special pleading has already begun. The US airline sector is already lobbying Washington for some US$50 bn of emergency support; and on behalf of US aerospace manufacturers Boeing is pushing for US$60 bn in loans and grants.
Some people might not stomach such support. After all, US corporates have led the world post-GFC in piling on low interest debt to buy back their shares to supercharge returns for their shareholders.
American Airlines is one of the most egregious examples. In 2015, it reported a US$7.6b profit, an astonishing rise from US$500m in 2007 and less than $250m in 2006. Factors included long pay disputes with its staff, cramming more passengers on its planes and charging excessive baggage and other fees. The multi-billion dollar profits kept pouring in over recent years. “I don’t think we’re ever going to lose money again,” Doug Parker, its chief executive said in 2017.
Meanwhile, American boosted its share price by spending more than US$15b during 2014-20 buying back its equity. It also shrank its cash reserves and borrowed heavily to finance new planes and to fit more seats in old planes. In 2017 analysts warned it was running the risk of default if the economy deteriorated. But the airline just borrowed more. Its current debt is nearly US$30b, nearly five times the company’s current share market value.
This is not an isolated example. In 2018, the Bank of International Settlements, the central banks’ central bank, released damning analysis of what it called “zombie companies.” These are ones which earn too little to cover even their interest payments. They survive by issuing more debt. This BIS video offers a summary of its research.
The BIS estimated 16 percent of all publicly traded companies in the US are zombies, and more than 10 percent are in Europe. Indeed, US corporate debt is now equivalent to 75 percent of US GDP, a record, and higher than before the GFC. Worse, the average US private equity firm has debt equal to six times its earnings. That’s twice the rate that defines a junk bond.
These are just some examples of the post-GFC corporate strategies which have generated unbelievable wealth for some investors but economic vulnerability for societies.
Covid-19 is creating economic mayhem which will purge some of these excesses. But once again governments and citizens will bear these socialised losses. That, though, is the price we will have to pay to minimise the depth and duration of depression.
That’s acceptable if this time we fiercely defend society’s interests over special interests.
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