Perspectives | COVID-19

COVID-19 and the Economy: Notes from the verge of a global crisis

By - 20.03.2020

The damage and opportunities from a crisis sparked by COVID-19.

While the relatively low mortality rate of COVID-19 compared to pandemics in the past is hopeful, the many uncertainties surrounding it cause a lot of concern. One of the uncertainties is its possible effect on the economy.

The jury is still out on the scale of the effects, but it is safe to say that the expectations are far from good. Simply put: We are on the verge of a huge global recession.

Before analyzing the links between COVID-19 and a possible economic crisis, we need to understand that crises are intrinsic to capitalism. In the past, they have happened more or less periodically, and the realities before the outbreak were not an exception to this. So, instead of assuming a direct causal relationship connecting the virus and the economic crisis, we have to see the virus as a spark that ignited the shake-up to the system.

These sparks are being struck by social distancing as a measure against the spread of the virus. Besides curbing the spread of the virus, the goal is also to avoid a potential collapse of healthcare institutions, which do not have the capacity to treat the entire population at the same time, even in the most developed countries.

Consequently, millions of people around the world are self-isolating, large chunks of China and whole countries like Italy have been quarantined, flights have been cancelled, squares emptied, borders, schools and universities closed, creating a pre-apocalyptic situation like a science-fiction movie.

Needless to say, these measures are necessary and no economic indicator ought to be put before health. Yet, although insufficient to predict the scale of damage that COVID-19 might have on the economy, this starting point is good enough to help us imagine the domino effect.

The immediate effect of all of these restrictions is a decrease in economic activity, which results in reduced production and higher prices.

However  dire the situation painted by an economic analysis, it should not eclipse our horizon. We need to take a step back in order to grasp that between current crises and future uncertainties lie possibilities with the potential of changing the world.

Expectations despite uncertainty 

Despite many uncertainties, we can form a series of expectations about the impact of COVID-19 to the global economy based on economic theory, referring to past trends and having witnessed the early cases in China.

The immediate effect of all of these restrictions is a decrease in economic activity, which results in reduced production and higher prices. Depending on the timespan, this can cause many people to lose their jobs and many businesses to shut down. The loss would be unequal: Small businesses and workers whose professions are seen as less important will be much more affected.

This problem becomes more serious when we consider that the harm inflicted by the 2008 Great Recession has still not fully healed in the European Union and elsewhere. Increasing public debt, deepening economic inequities, insufficient investment in activities that create jobs, the increasing risks of poverty on the unemployed and youth unemployment are some parts of its legacy in Europe.

In Kosovo, the country with the highest unemployment rate in Europe, the effect of an upcoming crisis would have even more dangerous dimensions. Still, this is not where the problem ends.

Expectations for the future are among the main factors that explain the interaction of economic agents, whereas uncertainties about the future comprise the biggest obstacle for expectations. As a result, withdrawing and holding back are the safest actions during uncertain times.

So, COVID-19, as an incidental and unpredictable event, will have a negative shock on supply. And, add to these uncertainties about the future, the shock will cause a withdrawal of investors and decreased investment.

Governments will bear the heaviest burden for stabilization — starting from decisions that directly affect healthcare systems to the creation of safety nets for the affected.

In the Eurozone, the level of investment in activities that create jobs and affect economic development was low even before the spread of COVID-19. Furthermore, in spite of problems with falling foreign investment and their substance in Kosovo, internal investment is also expected to decrease because of uncertainty.

COVID-19 will pose a negative shock to demand, too. Although the current supermarket frenzy caused by panic may not hint at it, continued isolation will expose the reduced demand. Even if businesses do not shut down, the fear from the virus will deter people from going to restaurants, cinemas, shopping malls, etc. Income will also decrease as a result of lower employment. Thus, a negative shock to demand is also inevitable.

With all of these developments, governments will bear the heaviest burden for stabilization — starting from decisions that directly affect healthcare systems to the creation of safety nets for the affected. In spite of that, they will be faced with many challenges because they will generate lower income from taxes and will be forced to make quick decisions that may not fulfill all the requests directed at them.

Monetary policies

The first signs that we are on the verge of a large global recession are already visible. Fear caused by the possible effects of COVID-19 on the economy and falling oil prices as a result of price war between Saudi Arabia and Russia have caused prices in the international stock market to mark a historic decrease. Panic triggered by uncertainty over the future has expedited the selling of stocks and increase of losses, which continues to happen.

This should also be concerning for Kosovo, knowing that about 1.5 billion euros or ¾ of its pension fund is invested in international markets. If these investments are damaged this could be the first direct effect of a global recession in Kosovo.

What makes this crisis even more worrisome is the uncertainty about the effectiveness of monetary policies by central banks. As you can see above, a big problem that comes as a result of the negative shock to supply and demand is a decrease in economic activity, which in turn translates to the lower circulation of money, especially of cash. This is where the role of central banks is essential.

During the 2008 Great Recession, central banks had a key role for reviving financial markets, securing liquidity for them. Specifically, the injection of money from the Federal Reserve (the US central bank) into the central banks, such as that of the EU, UK, Japan, etc., was crucial for continued functioning.

Now, there are two complications.

The first one is that, on March 15, the Federal Reserve slashed interest rates to near zero, and the Bank of England acted similarly. In reality, it has been a few years since many central banks in Europe have had negative interest rates. These measures aim to stimulate spending, which would increase consumption and investment. The result? Investments in Europe have reached pre-crisis levels only one decade after the Great Recession.

While in the United States, Wall Street marked the greatest one day fall since 1987 on March 16. The London Stock Exchange also keeps suffering losses. This is happening because there is an impression that central banks are running out of ammunition since neither near-zero interest rates, nor negative ones, will increase the credibility of investors that the situation will quickly improve.

The Central Bank of Kosovo has still not taken steps toward lowering interest rates.

The second one is that the US administration has changed, which has affected foreign policy. Shifting focus towards domestic issues and the tendency to withdraw from international cooperation cast doubt over the political will for potential financial aid by the Federal Reserve towards other banks in case of a financial crisis.

Even if this happens and central banks everywhere retain liquidity, i.e. have enough cash and assets that can be easily converted to cash to ensure normal operations, it is still unsure how much of the money will be funneled towards activities that will reanimate the economy and how much will be used to simply pay off public and private debt accumulated before and during the crisis.

The Central Bank of Kosovo has still not taken steps toward lowering interest rates. Although this will become necessary, it will not be enough. In spite of that, it should ensure liquidity, which could become a serious problem during the crisis. In Kosovo and elsewhere, panic could cause people to withdraw their money from checking and savings accounts, and this would open a Pandora’s box.

Fiscal policies

Uncertainties about the effectiveness of monetary policy, and the fact that they take a lot of time to have an impact, shift attention to fiscal policy. Even though governments will be faced with a decrease in income because of the deceleration of economic activity, they also bear the most effective weapon during this time — public finances.

The allocation of special funds for managing the pandemic, postponing deadlines for declaring taxes and credit payments (in cooperation with central banks), the creation of schemes for worker compensation, the possibility to directly transfer taxpayers’ money — these are some of the measures that have been taken or are being considered by governments around the world. Fiscal policies are decisive — they can either mitigate the damage of the crisis or worsen it.

As senseless as this may sound in these times of panic and uncertainty, we need to start reflecting now.

Governments that position themselves to mitigate the damage will prevail over this crisis better. They should initially create social safety nets (e.g. social schemes), through which they would protect citizens who lose their jobs and have lowered income. To finance them, stimulating fiscal packages are necessary, and they could be partially paid for by funds from organizations such as the World Bank and the International Monetary Fund. 

And, during the process, they should endeavor to stimulate demand, which will take a lot of time. It seems like this recession looks more like a “U” rather than a “V”: A quick fall and a gradual recovery.

Governments that try to rescue first-class passengers need to prepare for long-lasting turbulence. Prioritizing large corporations and the wealthy will only ensure the circumstances that cause crises; so, one thing will remain certain: The crises will persist. We have seen this recently during the Great Recession, and here we are again talking about another one.

It’s the system, not the virus

As senseless as this may sound in these times of panic and uncertainty, we need to start reflecting now. While we do need to take all necessary measures for overcoming the pandemic with as little damage as possible, we need to understand that we are also dealing with a very flawed system that will not improve along with the departure of the pandemic. So, we need to learn lessons sooner rather than later, and they include:

The limits of capitalism hinder an adequate response against disasters such as the current pandemic: Running after profit leaves many gaps that surface during crises such as the COVID-19 pandemic. Beginning from the insufficient production of necessary tests, the lack of interest of pharmaceutical companies to invest in vaccines that would save lives but not generate profit, to the lack of mobilization by private healthcare institutions. These and many others are indications of a system that does not stimulate the building of capacities for responding to the needs of the majority.

The state remains indispensable: This is the antithesis of the dogma of an unregulated economy or a self-regulating market. The market does not have the ability to fix a lot of the issues that happen within itself, and even less so issues outside of it. The hand of the state is visible from the mobilization of public healthcare systems for prevention and treatment, to the measures necessary for compensation after the crisis.

The wealthy have much more impact on government policies, so the measures taken for recovery from the crisis may not be equal for everyone.

Although indispensable, the state is insufficient: The illusion that borders and walls protect countries quickly peters out because the virus does not care about them. For this reason, regional and international cooperation is an inevitable necessity. So, now we need solidarity rather than competition, which is emphasized as a virtue of the globalized economy. The scope of international cooperation can be expanded by exchanging information and data and offering aid relief, among others.

Class remains decisive: This pandemic reminds us that class stratification can be used as an indicator for the potential to survive. Although, at first sight, it does not look like the virus discriminates based on class, the survival rate and access to treatment overthrows that idea.

The starving and the malnourished have weakened immune systems, so the fatality rate for them could be much higher. Furthermore, the wealthy have much more impact on government policies, so the measures taken for recovery from the crisis may not be equal for everyone. This deepens inequality, prolongs the current crisis, and creates fertile ground for forthcoming crises.

The paths after the crises

The last lesson is connected to two very serious problems that follow every pandemic: Misuse by traders and the exploitation of the situation by the elites. While the former clearly do it for profit, the latter do it for prevention. Shock doctrine, as Naomi Klein puts it, is used to hinder the opportunities for paradigmatic change that comes as a result of crisis.

Similarly, motivated by the Great Recession and referring to previous crises, Philip Milowski, talks about the ability of economic and political elites to utilize big crises. Is this going to happen with the next one too? It could, but it is not the only path.

For instance, as a response against the Great Depression, the largest economic crisis in the history of developed countries, the US introduced the New Deal, which contained programs, projects and reforms that aimed to decrease unemployment, improve the production conditions  in agriculture and industry and regulate the financial system to prevent a repetition of the crisis.

The same happened in many European countries, which, responding against the Great Depression and two world wars, created social schemes, applied progressive income taxation and improved worker conditions and rights. Thus, crises also open horizons and create new possibilities.

The job of drawing up alternatives is always ongoing — starting from specific proposals to fight wealth inequality to inclusive manifestos about the democratization and transformation of Europe.

As contradictory as this excerpt by Milton Friedman may sound here, considering his economic beliefs are market fundamentalist, this saying best explains the new horizons that can open up after the crisis:

“Only a crisis — actual or perceived — produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: To develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes the politically inevitable.”

And naturally, the follow-up question is: What are the alternatives? We need to understand that building them is a constant challenge, but it has already produced results. Motivated by the achievements of the New Deal, and aware of the high risk posed by the climate crisis, Green New Deals in the US and Europe are already part of political platforms. Of course, these are not the only ones, nor final solutions.

The job of drawing up alternatives is always ongoing — starting from specific proposals to fight wealth inequality to inclusive manifestos about the democratization and transformation of Europe. These and many others are only some of the projects indicating that it is not necessary to maintain the conditions that created the crisis after it is overcome.

Only time will tell whether these will find the required space for application, or if there will be similar alternatives. What is now clear is that the world will not be the same after this crisis. The issue lies with whether we will draw lessons and change course, or hope for different results while applying the same formula.

Feature image: Atdhe Mulla / K2.0.