Dennis Snower , a Senior Fellow at the Brookings Institution has produced an excellent paper on the unique economic policy challenges raised by a pandemic such as the COVID-19 crisis.
Snower begins with a summary of traditional Keynesian economics and government pump-priming during an economic crisis. The basic model goes like this.
Economies operate based upon Supply and Demand. An increase in Demand for goods and/or services creates a need for more Supply to meet that Demand. When companies cannot produce enough goods or services to meet the increased Demand, they have to hire more people or increase working hours that put more money in the hands of consumers who spend that money and create even more demand. Demand leads to a need for increased Supply which leads to increased Employment/Wages which leads to increased Demand.
When a non-pandemic economic crisis occurs, such as in 2008, there is a drop in Demand which leads to less need for Supply which leads to Unemployment that leads to even less Demand. The economy goes into a vicious downward spiral. Governments can break that downward spiral in two ways. First, governments can spend directly to create Demand by buying things like bridges, military equipment, and so on. Second, governments can put more money in the hands of consumers through tax cuts or direct payments. Consumers spend that money to create Demand. It is called Keynesian Pump Priming.
Keynesian Pump Priming doesn’t work as well during a pandemic where people have to engage in Social Distancing.
Snower explains that the economy consists of two distinct kinds of production and consumption activities—Physically Interactive activities and Physically Distant Activities. For example, waiters and customers in restaurants engage in Physically Interactive Activities—they have close physical contact. Contrast that with Food Delivery such as Pizza Delivery. Participants in Food Delivery are engaged in Physically Distant Activities. Consumers and delivery people have limited physical contact. Snower calls the Physically Interactive activities I-Chains and Physically Distant Activities D-Chains.
In a normal economic downturn, I-Chains and D-Chains respond equally to a typical Keynesian response to getting the economy going again. That’s not true when the economic downturn is caused by a pandemic such as the COVID-19 pandemic during which people have to engage in social distancing. I-Chains collapse. Keynesian pump-priming can’t bring them back to life as long a social distancing is in place.
Snower says during a pandemic we can, and usually do, end up with a Great Economic Mismatch regardless of the pump-priming governments provide. I-Chain jobs don’t come back while the demand for jobs in the D-Chain explode. For example, restaurants can’t reopen and re-hire waiters, food preparers, and so on because people are voluntarily engaging in social distancing or being required to do so. At the same time, demand for food delivery explodes and companies in that D-Chain struggle to meet demand since, for example, they don’t have sufficient production or delivery capability. Some I-Chain companies can switch to D-Chain but, for many, it isn’t that easy. For example, some restaurants can adapt easier to takeout, drive-through and delivery while others can’t simply because of the way their business is designed—they don’t have drive-through windows, delivery vehicles and drives, menu items that are well-suited for takeout or delivery and so on. Food producers that are set up to serve the I-Chain restaurants having packaging and delivery systems that can’t easily be converted to meeting the needs of D-Chain grocery stores. Food grown or packaged for the I-Chain may go unsold or may have to be discarded while D-chains grocery stores are unable to obtain sufficient supplies to meet a sudden increase in demand. Grocery store shelves sit empty while warehouses are overflowing with food packages in large containers for delivery to restaurants. Vegetables intended for the I-Chain rot in fields or are plowed under while grocery stores sell out of produce. Employees who work in the I-Chain may find it hard to transition to working in the D-Chain because they lack the necessary skills or tools to match the skills they have with the vacancies that exist in the D-Chain due to the explosion in demand. Additionally, D-Chain may be reluctant to invest in training out-of-work I-Chain workers for fear that they will lose these workers and their training investment as soon as Social Distancing ends and the I-Chain reopens.
If pandemics are rare and short-lived, the Great Economic Mismatch that Snower discusses may not matter that much. As soon as the crisis ends, I-Chains open back up and over-stressed D-Chains go back to normal. But, what if we experience more frequent and long-term pandemics in the future? Some research suggests that is exactly what is happening.
Research suggests that we can expect more pandemics like COVID-19, not fewer due to three major changes. First, the globalization of travel. In 1970 the world had 310 million air transport journeys. In 2018, the number of air transport trips had grown to 4.2 billion. People are traveling longer distances, more often, and taking infectious diseases with them. It is increasingly difficult to isolate an outbreak of infectious disease before it has a chance to spread not just to a neighboring country but to the other side of the world. Second, people are living closer together. It is estimated that nearly 70% of the world’s population will live in urban areas by 2050. Day-to-day social distance is becoming less and less possible for more and more people. The closer we are packed together, the easier it is for a virus to spread. Finally, there is climate change. Recent research shows that global warming is exposing larger numbers of people to infectious diseases. For example, the warming of the planet has been linked to the spread of viruses from bats to humans which is one likely source of COVID-19.
Snower argues that to avoid or minimize the Great Economic I-Chain/D-Chain Mismatch we need a Readaptation policy that provides incentives for people and companies to rapidly switch from I-Chain to D-Chain activities during a pandemic. Snower proposed Readaptation Policies for Labor Markets, Investments, and Financial Markets.
Labor Markets: One way to encourage rapid Readaptation in labor markets, says Snower, would be to provide D-Chain incentives during a pandemic to hire and train out of work I-Chain employees and incentives for online job search and matching services to provide I-Chain to D-Chain matching. These programs would be funded by providing out-of-work I-Chain employees with hiring and training credits that D-Chain employers would receive from hiring and training I-Chain employees. The number of credits an I-Chain worker had to offer a perspective D-Chain employer would rise with the duration of unemployment, fall with the duration of employment, and be totally phased out after two years.
Investment: During a pandemic, I-Chain company capital equipment sits idle while D-Chain companies can’t ramp up services to meet increased demand because they lack the same type of capital equipment. For example, I-Chain trucks and delivery vans sit idle while D-Chain companies experience a shortage of the same trucks and vans. Here Readaptation Policies would focus on providing incentives to I-Chain companies to convert or make available their excess I-Chain capital equipment for D-Chain use. Again, the policy would require online services that matched D-Chain needs to available I-Chain equipment and supplies.
Financial Markets-Here Snower is concerned about “debt overhang” or the overall indebtedness of governments, businesses, and individuals. He notes that many, if not most, corporations are highly leveraged. U.S. corporate debt reached $10 trillion in 2019 or 47% of the U.S. economy, a record high. Corporate indebtedness has been driven by cheap interest rates since 2008. Now we have a pandemic and the monetary and fiscal stimulus from the U.S. governments has come primarily in the form of loans that further increase corporate debt. Once the pandemic ends, many corporations may be carrying so much debt that they cannot borrow funds they need to get back up and running, even if the economy and consumer confidence are improving. Snower proposes two new instruments to mitigate the effects of debt overhang. The first is corporate bonds and loans where interest rates and repayment options are tied to corporate earnings. When corporate earnings fall below a certain loan, interest rates on these loans decline, and the corporation is allowed to postpone payment of principal and interest for a specified period. Second, corporate bonds and loans could be automatically convertible to non-voting equity when the ratio of corporate equity to risk-weight assets drops below a certain level. Such financial instruments would avoid bailouts for corporations “too big to fail”.
Would Snower’s proposals work? We don’t know. However, Snower is raising an important issue. Traditional Keynesian pump-priming to address an economic downturn does not work when the downturn is caused by the response to a pandemic. We need a different strategy to address pandemic-induced downturns which are likely to become more frequent in the future.
Read Snower’s paper here:
NOTE: Dennis J. Snower is President of the Global Solutions Initiative; Professor at the Hertie School of Governance, Berlin; Senior Research Fellow at the Blavatnik School of Government, Oxford University; Nonresident Senior Fellow at the Brookings Institution; and President-Emeritus of the Kiel Institute for the World Economy.