This article first appeared in Forum, The Edge Malaysia Weekly on June 8, 2020 - June 14, 2020
The world economic contraction so far this year is largely due to measures, especially at the national or local level, to contain or prevent Covid-19 contagion, particularly those restricting business operations, thus reducing economic activity, output, incomes and spending.
Lower business and worker incomes have reduced spending for both consumption and investment, and thus overall or aggregate demand. While there has indeed been much novel “financial folly” in the last decade, responsible for its dreary “recovery”, and financial circumstances will retard recovery, the cruel public health dilemma posed by the viral pandemic is surely its immediate cause for concern.
To be sure, recent economic performance in much of the world had been quite lacklustre, with no strong recovery since the 2008/09 global financial crisis and Great Recession, despite the unexpected impact of unconventional monetary measures, especially in the north Atlantic economies.
The recessions have been quite uneven, owing to different circumstances and responses. Various aspects may bear some resemblance to other supply-side recessions, for example, those caused or worsened by post-war conversion of armaments industries, oil price shocks (in 1973, 1979 and 2007) and shock therapy-induced “transformational recessions” in post-communist and other economies in the 1990s.
A general recession typically involves declines in many, if not most, industries, sectors and regions. Such output contraction typically implies underutilised production capacities, raising unemployment unevenly during a general recession.
In contrast, a structural recession refers to falling output in one or a few related industries, sectors or regions, not sufficiently offset by other rises. However, not all supply-side recessions necessarily involve structural transformation, especially — if not deliberately — induced by government.
A structural transformation, with unviable activities declining as more competitive options grow, may not involve overall economic contraction if resource transfers — from declining activities to rising ones — are easy, rapid and low-cost.
Such resource transfers typically require repurposing labour as well as plant, equipment and other fixed capital stock. Typically, unplanned structural transformations result in supply-side recessions, as resources are withdrawn without being redeployed for alternative productive ends.
Examples include post-war recessions when converting military industries to peacetime non-military purposes after wars end. After World War II, US output declined for three years, and was 13% lower in 1947 compared with 1944.
The 1990s’ recessions in many post-communist economies were similarly due to poor management of structural transformations, with declining agriculture and manufacturing, often despite more resource extraction. Some contractions were deeper than the 1930s’ Great Depression.
In market economies, such adjustments typically increase unemployment as industries become unprofitable — for example, because of cost spikes — and lay off workers. Growing unemployment lowers wages, while the conventional wisdom claims that cheaper labour costs will induce new investments.
Market resolution of such unexpected, massive disruptions is likely to be poorly coordinated, slow and painful, with high unemployment for years. Alternatively, governments can guide, facilitate and accelerate desired changes with appropriate relief and industrial policy measures.
Keynes needed but not sufficient
Slumps in travel, tourism, mass entertainment, public events, sit-down eateries, hotels, hospitality, catering, classrooms, personal services and other such activities have been due to physical distancing and other containment requirements.
Such collapses will not be overcome with support, relief and stimulus measures, as most such activities cannot fully resume soon, even in the medium term. Expansionary Keynesian fiscal and monetary policies to address collapses in aggregate demand have limited relevance in addressing government-mandated restrictions intended to contain contagion.
Furthermore, as Nobel economics laureate Paul Romer and Alan Garber note, “Loan guarantees and direct cash transfers will stave off bankruptcy and default on debt, but these measures cannot restore the output that is lost when social distancing keeps people from producing goods and services.”
Of course, relief measures for those losing incomes can help mitigate the effects of the adverse supply-and-demand shocks involved, but much depends not only on direct, but also indirect, second or even third order effects, partly reflected in Keynes’ “multiplier” muted by other government measures.
A necessary precondition for the multiplier to accelerate broader economic recovery is the prior existence of underutilised productive capacities. Otherwise, increasing demand will simply raise prices when output and efficiency cannot be quickly increased profitably.
One size does not fit all
Newly restructured economies will inevitably emerge from the pandemic, but some will do better than others. There is, and will be, greater need and demand for new as well as modified goods and services such as medical supplies, health facilities, care services, distance learning and web entertainment.
Economies trying to adjust to the new post-contagion context should use industrial policy or selective investment and technology promotion to expedite restructuring by directing scarce resources from unviable, declining, sunset industries to more feasible, emerging, sunrise activities.
Enabling, incentivising or even requiring needed resource reallocations can help overcome supply bottlenecks. China and other East Asian countries have already had some early successes in thus addressing their Covid-19 downturns.
All workplaces adversely affected by precautionary requirements will need to be safely reconfigured or repurposed accordingly. Structural unemployment problems, due to skill shortages not coinciding with available labour skill supplies, can be better addressed by appropriate government-employer coordination to appropriately identify and meet skill requirements.
Government policies, using official incentives, can thus encourage or induce adoption of desirable new practices, such as clean investments for “green” restructuring, for example, by using renewable energy and energy-saving technologies. Without such inducements, stimuli and support for desirable new investments, desired structural shifts may be much more difficult, painful and costly.
Thus, the ongoing Covid-19 crisis should be seen as an opportunity to make much-needed, if not long-overdue, investments in desirable sunrise industries, services and enterprises, including personnel retraining and capability enhancement as well as workplace repurposing.
Vladimir Popov is a research director at the Dialogue of Civilizations Research Institute in Berlin and author of How to Deal with a Coronavirus Economic Recession? Jomo Kwame Sundaram, a former economics professor, was United Nations Assistant Secretary-General for Economic Development.
He is the recipient of the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought.
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