Government after lockdown: Big or small?

Government intervention against the coronavirus crisis has been swift and significant. But what should the role be of government after the crisis? What will be the new social contract between society, business and government?

“The moral test of government is how that government treats those who are in the dawn of life, the children; those who are in the twilight of life, the elderly; and those who are in the shadows of life, the sick, the needy and the handicapped”

- Hubert H. Humphrey

The eerie stillness of our streets during lockdown belies the true nature of the health and economic impacts of the novel coronavirus. Individuals, companies and governments face an unavoidable moral dilemma, requiring decisions to me made with an apparent trade-off between life, death and economic growth. The stakes are high. Given the speed and uncertainty under which these complex decisions are made we have seen unprecedented actions from governments, central banks and businesses. In many cases, governments have overstepped their usual political and ideological boundaries and business have somewhat embraced stakeholders over shareholders. During a crisis this may be expected and ‘the right thing to do’, but what does this mean for the role of government after the pandemic?

The nature of the crisis

As mentioned, many decisions have and will continue to be made under significant levels of uncertainty and with a lack of accurate information. The virus is novel, meaning little is known of its infection rate, mortality rate, treatment successes, and the like. Naturally, this will change as the virus is better researched, but policymakers and decision-makers are not afforded the luxury of time and are compelled to make quick decisions with far-reaching short- and long-term implications.

It is for this reason that we have seen drastic measures such as national lockdowns. The aim is to lower the infection rate of the virus and keep the national healthcare system from collapse (possibly also to value life above all else). However, curbing non-essential activities has economic implications: We have thus seen a collapse in the ability for the economy to earn foreign and domestic (for now) income and a significant weakening of capital markets.

For the sake of argument, decision-makers were faced with two broad options (as illustrated in the image to the left: Baldwin & Di Muero, 2020): First, with little or no intervention there will be a massive spike in viral infections and deaths, followed by a quick decline once the virus reaches its carrying capacity (thus, where herd immunity is achieved). The impact on the economy will be ‘minimal’ and economic recovery will occur sooner rather than later. The second position holds that to limit deaths (flatten the curve) there is the need for drastic physical distancing. This may lower the healthcare impact of the virus, but possibly cause greater economic harm and require an extended recovery period.

Most governments have chosen the latter. Some chose the former, while others have no choice since they cannot afford or implement the interventions required.

Big government equals big action

Given the impending recession caused by lockdowns, government intervention has been what could be expected. There have been interest rate cuts of between 0.5% and 1% from most central banks since January, including the South African Reserve Bank (SARB). And especially the US has committed to an expanded government expenditure stimulus to boost economic activity. However, while effective at rebalancing the GDP during ‘normal’ recessions these actions may be less effective during a recession caused by a supply-side shock. During lockdown there is not a true lack of demand, but rather a lack of supply. What is required is to focus on the ability of the economy to recover post-lockdown. Thus, to ensure that enough businesses remain standing and people employed through the crisis to quicken the pace of recovery after the pandemic.

What is required is the ability for companies to maintain payroll, gain access to debt financing and for central banks to provide the latitude for banks to reschedule loans (possibly with forbearance through credit guarantees). For this, governments must pull out all stops in terms of fiscal action.

In a brief video conference with Prof Ricardo Hausmann, Director of the Growth Lab at Harvard's Center for International Development and the Rafik Hariri Professor of the Practice of International Political Economy at Harvard Kennedy School, Hausmann noted that governments should “create as much short-term fiscal space as possible” to allow businesses to survive the crisis and to promote the recovery. During this time, tax revenues will reduce significantly and one cannot rely on prudent norms (such as debt/GDP ratios) to inform decisions. These types of actions have already been seen. To keep the cost of government borrowing down, many central banks have committed to quantitative easing to increase money supply: The European Central Bank (ECB) and Federal Reserve have committed to practically purchase whatever is available and some rich countries have even started to purchase corporate bonds. Most countries (such as France and Britain) have endeavoured to make available credit guarantees to avoid bank and business default, in some cases by as much as 10% to 15% of GDP. In the US, business loans accessed during the crisis may be scrapped if no workers are retrenched. Britain has committed to paying as much as 80% of the wages for furloughed workers. And, much like in South Africa, banks and companies are offering payment holidays to customers.

It is expected for the global stimulus for the virus to be about 2% of global GDP in 2020, pushing up the average government expenditure as percentage of GDP from 16.6% to 18.6%. This is significantly greater than the stimulus seen in 2008/9. In 2018, this figure for South Africa was 21.28% (see image to the left). While it is expected for South Africa's GDP to retract by 2%, the SARB has warned that it may be as high as 4%. Hundreds of thousands of job losses and historic levels for the budget deficit can be expected.

Some advice for South Africa

For those able to afford these measures, there is less concern. But, like South Africa, many countries have limited fiscal latitude. Here the use of official external finance is required.

• Financing should be accessed from as many sources as possible, including the issuing of bonds, accessing the capital market, as well as a reliance on development banks, such as the IMF.
• Given that rich countries are currently buying up sovereign and corporate bonds, it would be wise to attempt to attract these funds to emerging markets. One way would be to boost South Africa's liquidity by accessing funds from the IMF. Further to this, the country may have to expand its use of any existing credit facilities that it may have.
• Finally, further funds from the central bank may be required to offer as credit guarantees against bank loans … especially if the lockdown period is to be extended. South African banks currently have about R540 billion available for credit relief after the Prudential Authority of the SARB relaxed rules on liquidity requirements and cash buffers. More may be needed.

What is most crucial is that these borrowed funds should be aligned to the life-cycle of the crisis and should preferably not have maturities beyond two to three years. And, these funds should only be allocated for crisis-related expenditures. Delaying the repair of a road outweighs the supply of healthcare in this crisis.

What does this mean for post-pandemic South Africa?

• First, it has become clear that there are limited sources of funds for cash-strapped economies during a crisis. Given the magnitude of the stimulus required, it is only the IMF that can truly offer what is required by poor countries. The IMF stated that it will mobilise its $1 trillion lending capacity to fight the virus. So, there should be attention given to the funding of regional development banks, which has now been found wanting.
• Second, the role of banks in the availability of funds during the crisis is clear. While South African banks have complied with the call from government to offer reprieve to its customers, perhaps the call for the establishing of a state bank will become louder after the crisis.
• Third, the central bank is a crucial lever for politicians during the crisis. Its willingness to print money, lower interest rates and function as a lender of last resort during the crisis may be incentive enough for politicians to want to rely on these measures more often. Even with no crisis.

The South African government has been decisive and clear on its chosen strategy to tackle the healthcare and economic crisis faced by the country. At this early stage, it appears that the measures are successful, but continued intervention is inevitable. Regardless of the actions chosen, the role of government cannot be denied. Which begs the question: What should the role of government be after the pandemic?

The new normal?

For the most part it is thought that the coronavirus is a short-term crisis and the measures to combat it to be 'temporary’. But clearly the economic impact of the virus may be somewhat more protracted. So, expect a transition to recovery.

The Economist, drawing on the work of Adolph Wagner, a German economist and politician (1835-1917), makes reference to the history of government spending, state power and the difficulty of these powers to be repealed after crises. As mentioned, the percentage of government expenditure to GDP is about 16.6% (2018) and it is 38% for the rich world. Compare this with 5% in England up until the early 1900s, prior to which the government made no contribution to public healthcare or education. Other examples of this increase in the role of the state can be found just about everywhere. And, as the role of the state increased, so did its requirement for taxes.

Even during times when government expenditure was drastically reduced (as was the case with Reagan in the US and Thatcher in Britain), bureaucracy increased in order to manage the increasingly complex economy. Wagner states that as economies become more complex and richer, the requirement of government to assist in the managing of complexity also increases and that while these interventions may be temporary, it becomes harder to undo. For example, the provision of social grants in South Africa will be extremely difficult to repeal. And is it not a normal expectation for government to supply public hospitals and schools? This was not always the case. An interesting example is that of Canada, which implemented income tax as a ‘temporary’ measure in 1917 to fund its war effort. It is during crises, particularly wars, where government expenditure and its power in an economy rise. Governments are not only expected to run military activities (which are highly complex) but also to pay for it (with higher taxes). It was perhaps unimaginable prior to WWII that the government would be able to control telecommunications, transport, healthcare and education in England, but it took nearly four decades for only some of these monopolies to be broken.

Government intervention during the pandemic has not only been welcomed by many, but has been expected in most cases. Similar to 2008/9, governments have moved to act to protect the free market, but in many countries the interventions for the coronavirus have been more radical and, in cases such as lockdown, infringe on the civil liberties of citizens. Putting a freeze on the free market by way of lockdown is counter to the political and economic ideologies of many countries who acted nonetheless. The question is how the power of the state will be repealed once the pandemic has passed? 

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Sources:

Baldwin, R. & Di Muero, B. 2020. Mitigating the COVID economic crisis: Act fast and do whatever it takes. CEPR Press.

Bloomberg. 2020. Everyone is flying blind. Bloomberg New Economy. 4 April 2020. Online [Available]: https://www.bloomberg.com/news/newsletters/2020-04-04/everyone-is-flying-blind-on-covid-19-bloomberg-new-economy

Hausmann, R. 2020. Covid-19: Macro-economic consequences for developing countries. Video conference. 2 April 2020.

The Economist. 2020. Rich countries try radical economic policies to counter covid-19. The Economic Briefing. 26 March 2020. Online [Available]: https://www.economist.com/briefing/2020/03/26/rich-countries-try-radical-economic-policies-to-counter-covid-19

The Global Economy. 2020. South Africa: Government Spending , percent GDP. The Global Economy Data. Online [Available]: https://www.theglobaleconomy.com/South-Africa/government_size/

Trading Economics. 2020. South Africa Government Spending. Trading Economics Data. Online [Available]: https://tradingeconomics.com/south-africa/government-spending

Wagner, A. 1890. Finanzwissenchaft. Leipzig: C. F. Winter.