Lockdown: Macro Economic Consequences and Analysis
This century witnessed the worst healthcare crisis of its time, The Coronavirus Pandemic. The virus causes the disease named COVID-19. The virus is first said to be appeared in Wuhan city of Hubei Province of China. The speed and scale of spread of the virus can be gauged from the fact that with a span of 6 months, almost every country on this planet was witnessing its citizens falling prey to this tiny, invisible to the naked eyes virus. The world had witnessed a similar kind of crisis exactly a century back in 1920s when the entire world fell prey to the Spanish Flu[1] Virus. Many similarities have been drawn between both the events but clearly the impacts vary due to increased interconnectedness of the entire world. And as the coronavirus continues to unleash its wrath, the governments around the world emphasized and have been emphasizing on the proven public health measures, such as social distancing, lockdowns, restrictions, partial closures etc. to physically disrupt the contagion as the cure is still a distant feat to achieve. But, doing so has severed the flow of goods and people, stalled economies, and is in the process of delivering a global recession, as suggested by IMF and other economic houses. Economic contagion spread faster than the disease itself and many other economic impacts are still to take shape as there are lags in built in any economic downturn. Since, the shutting down almost everything (except essentials) was the first actions witnessed, the pandemic has hit the economies around the world on various fronts. In India only 25% of the economy[2] could function during the lockdowns imposed by the government. In this article, we would be exploring the impacts of lockdowns and closures on the macroeconomic level. These lockdowns were subsequently lifted in many parts of the world, but governments faced the dilemma of preventing increase in number of cases and deaths and preventing an economic catastrophe. Governments now also face a challenging task of handling with the requests from various sections of the market regarding relaxing in labour laws, taxation, cash assistance in order to cut the losses. Fiscal stimulus if often touted as the path for governments during times like these but does that really work and brings desired benefit? If yes, then what could be the mechanism? Governments and experts are saying that the economy would bound back within few times but will this really be quick given the constraints in production, labour fallout due to these lockdowns and social distancing measures in place? How quick the recovery will be? Since development of vaccine for a disease takes a lot of time, it becomes pertinent to understand what should countries do if they again have to impose lockdown due to increase in number of cases. The analysis will be mainly from the Indian perspective.
Modern Kaleckian[3]-Keynesian framework for economic theory and policy:
The modern Kaleckian (1971)-Keynesian framework explores a short-term analysis of circular flows of income and expenditure used by a Capitalist economy with Keynesian emphasis of investment in the economy (sometimes also referred as stimulus in the economy). The original framework’s assumptions of economy consisting of two classes i.e. workers and capitalists was further modified by later economists (Kumar (1999)) to incorporate government. The following equation was derived:
{Pp + Int. – Tp} = Cc + Ip + (Fiscal Deficit) -------------------(1)
Where Pp is is the volume of gross profit, Cc is consumption, Ip is investments, Tp is taxes and interest paid by the government. In the nutshell, the above equation is used to study the impact of government policies in a capitalist economy (presumably).
Lockdown- The Three periods:
Lockdown is a temporary shock to the economy which leads to sudden disruption in productions and demands. It a short-term phenomenon. In the search for normalcy which existed before Lockdown, there follows another short period after the lockdown is lifted during which normalcy restores itself from 0 to pre-lockdown period. Therefore, three periods can be written as:
1. Pre-lockdown period
2. Lockdown Period
3. Post-lockdown period.
The post-lockdown period has an important characteristic that fresh investment (except from government) is difficult to find due shock and uncertainty in the environment. Therefore, comparative analysis of the three periods based on the above mentioned Kaleckian framework may shed some light on the economic impacts and the possible path for a government in terms of policies and stimulus.
Lockdown is primarily characterised from the supply side perspective and results in halt in production, stoppage in labour wage payment. In India there is a large unorganised sector which needs to be taken into account while doing any consequence analysis of lockdown as this sector is the most affected but less visible to the formal analysis of the government. Therefore, modifying the above equation with separation of organised and unorganised sectors,
{Pp + Int. – Tp} + [(Wo – To)] + [Wu+ Su] = Cc + Ip + Co + Cu + (Fiscal Deficit) ………..… (2)
Here, Wo is the wages of organised labour force, Wu is the wages of unorganised labour force, Co is the consumption of organised labour force and Cu is the consumption of unorganised labour force and Cc is the consumption of capitalists. Su is the subsidy provided to the unorganised sector. Now this equation will be used to study the impact of lockdown by studying various factors that affect the equation.
Impact of Lockdown[4]:
Features of Lockdown:
(1) Direct and most visible impact is that the production of goods and services is reduced to a significant extent in most of the sector (not zero because production of essential goods and provision of essential services). Essentials also suffer due to logistics and labour constraints.
(2) In non-essential sectors, capacity utilization falls to zero.
(3) The demand of perishable items falls due to fall in demand.
(4) There is a sudden dramatic fall in employment (the immediate painful effect for unorganised sector).
(5) Capacity utilization across businesses falls due to which there is a fall in the investment in the economy.
(6) Since government’s focus is diverted towards responding the crisis situation there is a short-term fall in public investment due to budget constraints.
(7) Investment in the private sector fall to negative as there is continued depreciation burden and use of existing reserves in surviving the lockdown period.
(8) Household saving falls as people use up their resources to survive the period. This effect is more visible in the unorganised sector.
(9) Due to fall in demand, the prices of the commodities are expected to fall, except for the essential items. For any conclusory evidence regarding the price the duration of the lockdown plays a very important role.
(10) Overall, a deflationary[5] trend sets in the economy.
Now, with the help of equation (2) and the above-mentioned characteristics, impact of lockdown can be described as:
Impact on Output:
Since, immediately after lockdown has been declared, the production stops but capacity still exists. Inventory management become the most important issue for production-based businesses. In this scenario, Ynow << Ycapacity i.e. output in lockdown is less than output at normal capacity. Due to this, there is a fall out in wages and profits. For the unorganised sector, Wu =0 and for the organised sector (Wo)lockdown < (Wo)normal
Impact on Income: Income Falls[6]:
· (Wo)lockdown will fall sharply due to wage cuts taken by businesses to manage short term losses and unemployment fallouts due to situations.
· Since unorganised sector is hit badly, wages for unorganised sector drops to almost zero, Wu =0
· (Pp)lockdown becomes constrained due to the fall in production
In this situation, some profiteering from trade in essentials in the form of black income is inevitable, but since it is so small, it can be assumed to zero.
Impact on Prices:
· Due to fall in demand, commodity prices fall (except for daily essentials).
· Consumer’s consumption basket becomes limited to essential items.
· Since ensuring safety measures meaning extra costs for businesses, therefore post lockdown, prices increase.
Impact on Consumption:
· Since lockdown closes doors for everyone be it lower class or capitalists, hence Cc falls.
· Co and Cu falls down[7] as the consumption basket becomes limited to essential items.
· Since consumption for unorganised now becomes dependent of on the government hence, subsidies from Government i.e. Su rises[8].
Investment[9] and Fall in Household savings:
· Since lockdown affects businesses profitability hence new investment from them take a big hit and almost falls to a very minimum amount during this period, Ipvt become minimum or negative.
· From the government side, since initial focus is towards dealing with the crisis in hand hence any new investment from public sector i.e. Ipub falls drastically initially and it gradually picks up as government infuses money into the system in order to save the economy and do its welfare duty.
· Since income of almost all the sections falls, hence savings take a hit during lockdown.
Impact on Government Revenues:
Revenue for the government can be written as,
Revenue for the government = Tax Revenue + Non-tax revenue.
Tax revenue of the government = Taxes from businesses (Tp) + Taxes from organised sector (To) + Indirect taxes (Ti)
· Since profitability of the businesses falls, hence Tp falls drastically during lockdown.
· Since there are wage cuts and unemployment in organised sector workforce, hence To falls drastically during lockdown.
· Since consumption of commodities other than essential items falls significantly, hence indirect taxes also fall drastically since essentials either provide 0 or very low taxes to the government.
Hence, the revenues of the government fall[10] drastically during lockdown.
Impact on Budgetary expenditure for government:
Expenditure for the government can be written as,
Expenditure for the government = Int. payment + Salaries + Investment + Subsidies + Other transfers and purchases
Out of the above-mentioned expenditures, int. payment and salary expenditures for government are committed in advance, investments during lockdown are least concern for the government (hence almost zero). Since, welfare of the unorganised sector falls onto government (specially in crisis time) in lockdown so, subsidies rise. Therefore, budgetary expenditure for the government increases during the times like lockdown.
Impact on Fiscal Deficit:
Fiscal deficit for the government can be written as,
Fiscal deficit = Expenditure- Revenue
Since during lockdown budgetary expenditure for the government rises and revenues falls as shown above, hence fiscal deficit for the government will rise[11] significantly.
Financing the Fiscal Deficit:
Since during lockdowns government is constrained to make any increases on the taxes part for managing its losses, the only viable option for government remains is to increase its borrowings from outside sources. Some of the ways to finance the deficit for the governments (specially for a county like India) can be[12]:
· Grants and loans from bilateral development agencies and multilateral financial institutions
· To issue rupee-denominated government bonds
· To introduce a wealth tax and impose higher taxes on the super-rich individuals. This will be effective only if implemented with proper policy formulation and some kind of business incentives provided to the super rich individuals since most of them are part of the vibrant business community of the country and any such on-way enforcement might not go down well.
· Debt monetisation, under which the Central Bank of the country would buy bonds directly from the government.
Post-Lockdown Scenario: How countries could approach for Economic Revival?
Lockdowns are a temporary phenomenon; the impacts of these lockdowns are that the economy doesn’t come-back to its original level all of sudden. The consumption remains tepid for a significant period of time till normalcy restores:
· Due to decrease in wealth generally, people consume less than the previous levels.
· Wage cuts, unemployment make people to consume less.
· Investment from private sector remain tepid or zero, investment from governments increase but at a slow pace since government also faces revenue crunch.
Therefore, time plays a crucial role for the revival of economy and it is only after a certain period of time, ranging from 1 to 2 years, that normal level of productions is expected to reach. Return to normalcy will also depend on some other factors, like in this COVID scenario until a vaccine comes to the market, people sentiments are poised to hinder the economic revival. Many a times typical response from a government for revival of economy is to focus on organised sector which is relatively easier to manage but for any stimulus package to have some meaningful effects on the economy, governments should concentrate on the unorganised sector and the MSMEs which provide significant portion of the employment to the unemployed (specially in a country like India). Specially for India. considering the population its size, fiscal stimulus would have to be large enough to produce any desired effect. The recent stimulus brought by the government inadequate due to the sheer size of the affected population. This is a structural issue and government will have to do more. Government should emphasize on the unemployment front more vigorously with special emphasis on unorganised sector as it will lead to spurt in demand which contains the ray of hope for economic revival.
[1] https://en.wikipedia.org/wiki/Spanish_flu
[2] https://thewire.in/economy/india-economy-gdp-q1-decline-coronavirus-lockdown
[3] https://wiiw.ac.at/kalecki-s-profit-equation-after-80-years-dlp-3020.pdf
[4] https://www.epw.in/journal/2020/39/special-articles/macroeconomic-consequences-lockdown-and-its-policy.html
[5] https://www.business-standard.com/article/economy-policy/covid-19-impact-it-is-wpi-deflation-for-the-first-time-in-56-months-120061500984_1.html
[6] https://theprint.in/economy/over-80-of-households-in-india-lost-income-due-to-lockdown-says-study/422418/
[7] https://theprint.in/economy/india-to-see-recession-due-to-worsening-consumption-investment-demand-monetary-policy-panel/436454/
[8] https://www.financialexpress.com/economy/modi-govts-largest-ration-subsidy-scheme-for-80-cr-indians-buy-rice-wheat-at-this-price/1909103/
[9] https://scroll.in/latest/962434/coronavirus-lockdown-foreign-investors-pulled-out-more-than-16-billion-from-india-says-report
[10] https://www.prsindia.org/theprsblog/impact-lockdown-government-revenue
[11] https://economictimes.indiatimes.com/news/economy/indicators/fiscal-deficit-to-touch-7-in-fy21-says-brickwork-ratings-as-revenue-collection-hit-by-lockdown/articleshow/77833871.cms
[12] https://thewire.in/economy/covid-19-india-economic-recovery