Drafting a COVID recovery − free markets, government intervention, monetarism or bust?

On 7 March Malta woke up to the first case of COVID-19 and a few weeks later, the health authorities reacted efficiently by imposing national wide orders for social distancing and wearing face masks, imposing lockdown of many sectors, the closure of all sea and air ports: the latter opened (some say rather hastily) to welcome visitors in mid-July.

Businesses operating within the tourism and designated retail sectors came to a complete standstill. In a panic move to safeguard jobs, government financed a furlough scheme. Lobbyists assured it will be sufficient to fight the first wave and driving the “R factor” below one. Cavalier attempts were drafted to help firms improve access to credit by issuing free guarantees to retail banks from a State development bank when the former lend to firms in distress.

The take-up was modest, so the question on everybody’s lips is: what is the best medicine to administer to the patient? Lately, much to the chagrin of many, who made untold sacrifices during the rigid threemonth lockdown, the island’s health defenses were breached (due to political rhetoric “let us enjoy summer” brandishing rave parties hubris) and, as predicted Malta has been hit with a second pandemic. Most EU countries are grey listing it as a risky tourist destination.

Nobody can bring the genie out of the bottle, so let us briefly review how since the post-war period, successive governments experimented with various economic remedies. This debate on free markets dates back to 1776 and since then no consensus was reached as to which strand of economic thought is most efficacious. One of the biggest advocates for a market rule model was the 18Th century economist, Adam Smith. In his seminal treatise, The Wealth of Nations, Smith argues that having everyone act in their own self-interest, leads to an optimal outcome. In other words, Smith proposed that by giving everyone freedom to produce and exchange goods as they please (free trade), and opening the markets up to domestic and foreign competition, people’s natural self-interest would promote greater prosperity than with stringent government regulations.

This free market doctrine implies that in the absence of government intervention and with everyone acting selfishly, the market would eventually reach equilibrium on its own, as if by an “invisible hand”. Another argument emphasised by advocates of free markets is personal freedom. Government intervention is likely to take away some of the freedom that citizens enjoy in terms of what and how much to consume. Economists argue that under this regime, producers are incentivised to produce what consumers want at a reasonable and affordable price, as if guided by the invisible hand. Moving on, modern markets follow a capitalism economic system, simply put that private individuals own capital goods such that production is based solely on the markets’ supply and demand rather than through central planning, so popular in totalitarian regimes. Almost all of today’s economies feature elements of “free trade” laced with a varying degree of government intervention. The justification for government intervention is that free markets do not always lead to an optimal and efficient outcome, so intervention is de rigueur. Typically, government intervention can improve society’s welfare when there are market frailties for example, monopolies, oligopolies, cartels, externalities and the abuse of common property rights. Hot on the heels of the chaos bequeathed at the end of Second World War, one reads about the dominance of a British economist John Maynard Keynes. Keynes advocated an expansionary fiscal policy to stimulate aggregate demand and hence pull the global economy out of the depression. More specifically, Keynes argued that in order for an economy to improve its conditions, greater government expenditure (direct injections to the economy) is required while simultaneously reducing the leakages within the economy by reducing taxes.

With lower taxes and greater government expenditure, the money supply within the economy increases. As the money in circulation increases, households and firms are able to spend and invest more money, hence stimulate aggregate demand. Likewise, one observes how this was the motor that fuelled the exemplary GDP growth in Malta, which in 2018 alone exceeded 7% (the highest in the Eurozone). Many recall, how rapid expansion of aggregate demand since 2013, was a consequence of an explosion in residence permits issued to expatriate staff (apart from the millions collected from sale of passports and a runaway property bubble). These contributed in no small way to a higher consumption generating unprecedented levels of economic activity, boosting output to meet the new higher demand. As employment levels grow, people’s disposable income increases, to further lift one’s consumption and stimulate more affluence (albeit an artificial one).

In short, in the post COVID slump, our political leaders can take a leaf from Keynes theory to reduce consumption taxes, invest more in much-needed infrastructure projects and spurned with EU recovery stimulus funds, bet on quality tourism. Start by trimming down excess bed stock and nonperforming property loans (an albatross around the neck of banks). Moving on, we notice how Keynes’ philosophy dominated the first half of the 20th century, which was then superseded by the economic theories proposed by Milton Friedman. Friedman developed a “Monetarism” theory. One may remark that this theory proved successful for a short term but post the 2007/9 crisis, it lost its shine when the globe is facing an acute slowdown. Since the global recession of 2007/9, after the ploughing in of massive TARP rescue funds in the USA, the global economy took an unusual pattern. It manifested anaemic growth with an unusual cocktail of low unemployment, low inflation and low interest rates. This turned the creed of the classical economist upside down and led to a massive drive by central banks to indulge in Quantitative Easing to calm the waters.

Back to Malta and a sure-fire solution is not easy but certainly surgery is better than tinkering with palliative care. Both tourism and credit institutions have reported weak results. A maverick elixir will see government set up an SPV, which can buy non-performing assets, such as those hotels and nonperforming loans, including any collateral assets and over a period of five to 10 years manage such a toxic portfolio until an equilibrium level is reached. Certain hotels saddled with a dismal ROI, can be acquired by the Fund and acreage transformed in recreational parks or erecting more affordable social houses, thus embellishing the island and rendering social value to society. Alternatively, a piece meal solution by populist tinsel will simply squander millions and administer a band aid plaster when only surgery has the magic cure.