Hysteresis and economic recovery
In the March 21 issue of the
Chicago Booth Review, Richard Baldwin of Geneva’s Graduate Institute, wrote that “minimizing disruptions to workers and businesses will be expensive. (But) it’s worth it.”
We cannot disagree more. Instead, public authorities must choose quick wins that “keep the economy’s lights on without worrying too much about costs.”
Baldwin proceeded from the premise that the “medical shock is transient.” So far, global evidence is strong that it is not.
The reality is that the shock has assaulted the G7 nations and China, all at the same time. The attack is not only sporadic. It is broad based. It is not confined to one or two markets in the same way that a banking crisis originates in the banking system, or that an exchange rate crisis is birthed in the FX market and central bank reserves.
The current crisis is not as simple.
A series of community quarantines has resulted in several medical and economic paradoxes. Economic activities have ground to a halt, forcing creativity, digital platforms and new business models to revive them.
Pervasiveness of the virus, reported to be less potent but more infectious, has drastically changed social norms. Just last year, we would never have imagined that to enter a bank, masks would be required, or that everywhere, security guards would have temperature scanners in their holsters.
In a publication, Economics in the time of COVID-19, Baldwin together with Beatrice Weder di Mauro, identified three familiar COVID-19 shocks: 1.) workers confined to their sickbeds, paralyzing potential spending; 2.) restricted productive activities and travel because of public health mitigation measures; and, 3.) general business reticence.
Baldwin concluded with the advice to “keep the lights on.” He went on to say that the accumulation of “economic scar tissues” must be reduced. To do so, the “number of unnecessary personal and corporate bankruptcies must be reduced.” He proffered that people must have money to keep spending even if they are not working; “a side benefit of this would be to subsidize the sort of self-quarantine that is needed to flatten the epidemiologic curve.”
There are two problems with Baldwin’s formulation.
The first problem is social. We have not yet even healed. We cannot yet boast of “economic scar tissues.” We are still wounded. We are still bleeding. Baldwin believed that the medical shock would dissipate shortly, that even with mortalities, the workforce would not be reduced significantly or permanently. But, this is not the case as death is permanent. And many deaths have already ensued and families are in mourning.
The second problem is economic. Economic scar tissues appear only after an economic recession. Restarting the economy by granting people money to spend in a lockdown is anachronistic. Money can only keep people alive if they can go out and buy something to eat. Thus, a subsidized self-quarantine will only very slightly help “bend” — but not really flatten — the curve.
Baldwin also endorsed the proposal of a group of economists led by Paris School of Economics’ Agnes Benassy-Quere (VoxEU. org, “COVID-19: Europe needs a catastrophe relief plan”). The proposal is premised on four partially overlapping phases. The
Europeans believed Phase 1 or the China shock would only be good for the first quarter. Phase 2 covers sectoral disruptions in tourism, air transport, hospitality and entertainment starting in February (with a rather small expected impact). Phase 3 was to start in early March in Italy, but in the second quarter for the others. During this phase, there would be acute overall disruption because of broad-based strict measures like travel bans as well as shutdowns of public transport and schools. Phase 4 is sweet recovery.
In their analytical framework, recovery was projected as early as May or June. By now, this assumption has been rendered extremely unrealistic. The writers however were correct in qualifying that their assumptions would only hold true sans the hysteresis of: “confidence effects; lost corporate income in the services sector; bankruptcies among SMEs; credit constraints from the accumulation of non-performing loans on banks’ balance sheets; and the rebuilding of dented savings at the household level.”
In the Philippines, Phase 4 is a pipe dream as the coronavirus is still alive, rampaging and kicking, with the epidemiological curve refusing to be flattened. It is too early to talk about economic scars. Just like the rest of Asia, the US, and most of Europe, a sharp rebound or a V recovery may not be likely precisely because of hysteresis.
Therefore, it would be premature, perhaps incurably optimistic, to pin hopes on one or two green shoots, or to conclude that because the second quarter was the “worst hit by the pandemic,” that the third and the succeeding quarters would be more bearable. Regardless of the standards used, yesterday’s announcement of the
Philippines’ real GDP decline of 16.5% for the second quarter 2020 is certainly a very deep wound that would take time to heal.
As infections continue to rise, and as the rest of Southeast Asia predicts us to be its COVID-19 hotspot, has our curve already peaked? Without a national plan to strategically test, trace, and treat, can we really say — both in terms of the pandemic’s social and economic impact, “that the worst is over?”
We would love to be proven wrong. Like many of us, we always say a prayer for our country and people. The past two miserable quarters are now behind us; left and right of us many economies have claimed initial victories over the pandemic; ahead of us remains unclear. The best way is to be strategic and work hard and seek favor from above.
Indeed there are red flags ahead. There have been reversals in key economic and financial market indicators. Leading indicators like purchasing managers’ index, business and consumer expectations, bank credit and liquidity growth are not looking up. Lagging indicators are not suggesting resiliency; corporate failures have become rampant in the airline industry, food and beverage industry and retail trade. Bank profits are way down. Factory output in volume terms declined in June for the fourth time. This is also reflected in the flat sale of energy in July.
In the food industry, while Century Pacific was in good shape with over P2 billion in net income for the first six months of 2020, Jollibee sustained a P10 billion net loss in the second quarter. By the end of this year, Jollibee expects to slash its number of stores by 416 or 7%. While it is reengineering, this loss will also translate into job and income losses for many. The economic scar will be felt even beyond 2020.
Mainly in power, water and infra, Metro Pacific profits dropped 63% following the disruption brought about by the viral pandemic. It is good for Metro Pacific
to continue making investments “that will help the Philippine economy recover.” Its president and CEO was also wise to clarify that this will be executed without incurring additional leverage. Otherwise, the wounds will take more time to heal; the scars will even be thicker over time.
This is the reality of hysteresis. Even after the health emergency, there could still be a protracted struggle. The economic scars will prevent resumption of our precrisis economic path. The wounds may be deepest in the second or third quarters, depending on the ability of the authorities and civil society to be one in implementing a strategic plan of action against the virus during this two-week lockdown. This will help bolster consumer and business confidence and mitigate hysteresis. More confidence will break the debilitating effects of reticence; and stop the relentless assault of the pandemic on life and livelihood.
While monetary policy seems to have maximized its space, fiscal policy has more mileage. Debt and deficit metrics remain robust and therefore, for 2021, a higher budget is proposed for health and economic recoveries. An early passage of the budget is extremely critical. Unnecessary distractions should be avoided.
Against the potential havoc of a prolonged hysteresis, good, judicious and sustainable fiscal expenditure should be supported. While funding for the electoral exercise in 2022 could also help stimulate the economy, some of its extraneous component is the least of spending we need at this time.
DIWA C. GUINIGUNDO is the former Deputy Governor for the Monetary and Economics Sector, the Bangko Sentral ng Pilipinas (BSP). He served the BSP for 41 years. In 2001LUIS 2003, he was Alternate
Executive Director at the International Monetary Fund in Washington, DC. He is the senior pastor of the Fullness of Christ International Ministries in Mandaluyong.