As the world stares into the face of the most widespread public health crisis in a century, the immediate response should be medical, taking aggressive steps to slow the contagion. But we must not lose sight of the mounting economic calamity on the horizon. The outbreak will cause widespread economic damage, and we must act quickly and carefully if we are to foreshorten our first recession in over a decade.
The key thing to grasp is that this will be no normal recession. Economics textbooks don’t cover how to deal with the fallout from a global pandemic.
In a normal recession, the Keynesian response calls for getting cash in the hands of consumers so that they increase their spending, pumping the economy back up again. This relies on what economists call the “marginal propensity to consume”: the degree to which consumers take that cash and spend it, rather than save it.
A pandemic, however, depresses the marginal propensity to consume. And for good reason. As a matter of public health, many should not go to work or school, or out to eat, drink, shop, see a movie, etc. The immediate halt to activity is an essential public health measure.
So in the current moment, a Keynesian stimulus will most likely result in many consumers taking the cash they receive and putting it in the bank. In the face of the pandemic, our standard monetary and fiscal tools are impotent against an unavoidable decline in activity.
But that doesn’t mean we should do nothing.
The pandemic will cause a large gap in the incomes of many households and businesses over the next few months. Some will be able to weather the storm by accessing savings or loans. But many won’t. Millions of workers will lose hours, wages, or even their jobs. Thousands of businesses that were operating on thin margins before the crisis will be pushed beyond the brink.
Many of the policy proposals being floated are of the classic Keynesian variety.
In his address from the Oval Office, President Trump proposed a fiscal stimulus consisting of employee-side payroll tax cuts and bailouts for select industries. Many economists have expressed a preference for cash payments—either to all households, as suggested by Obama CEA chair Jason Furman, or to those most directly affected by the virus, as preferred by AEI economist Michael Strain.
Because the pandemic depresses the spending response to fiscal stimulus, fiscal efforts should be configured not with a view to boosting economic activity but to plug the hole in the budgets of the most vulnerable households and businesses over the months ahead.
A well-designed package should contain two elements:
- Support for vulnerable households—along the lines of Strain’s proposal above—will help these households navigate the period of depressed economic activity that we are about to enter.
- Support for directly affected vulnerable businesses will help these businesses bridge the inevitable gap in revenues caused by the necessary economic slowdown.
Many proposals have called for the first element, but the second is just as important if we are to avoid widespread business closures.
Many of these businesses would be otherwise viable, taken out not because of bad decisions but because of a once-in-a-century pandemic that’s difficult to hedge against. And with those closures go all the valuable things these businesses have worked hard to build—the products, processes, knowledge and relationships that make them unique.
If these closures were allowed, it would take a long time for new businesses to form, raise capital, grow and hire new workers. It would be a surefire recipe for a long and painful recession.
Instead, with a temporary financial boost by government, these businesses could float through the crisis and, once it lifts, spin back up quickly—scaling up hours for their workers, purchases from their suppliers and sales to their customers.
The goal is to sustain the businesses underpinning the economy so that activity can snap back as quickly as possible once the pandemic has been brought under control. Government loans, as proposed by President Trump, will play an important role. But they won’t be enough. Many low-margin businesses will have difficulty servicing these loans on the other side of the downturn.
There are other options worth considering:
- An employer-side payroll tax holiday would provide immediate support to millions of businesses, cutting labor costs by up to 4.5 percent, and reducing the incentive to lay off workers.
- Changes to net-operating-loss provisions, like rolling back to the settings prior to the introduction of the Tax Cuts and Jobs Act, would boost business incomes and support investment.
- Reductions or suspensions to tariffs currently imposed on American businesses would replenish cash flows and remove a damaging distortion.
- Delaying Quarter 1 and 2 tax payments for businesses, as suggested by Nicole Kaeding at the NTUF, would give businesses much-needed breathing room.
- State governments should consider payroll or sales tax holidays to support businesses in their state.
- All state governments should be supported in their efforts by the federal government, through increased Medicaid matching rates and other funding mechanisms.
An ambitious package of support for businesses is justified by the peculiar nature of the shock.
It’s important to understand that this virus-driven recession won’t generate Schumpeterian creative destruction. Rather, it’s going to harm a range of otherwise viable firms. This will destroy significant amounts of firm-specific capital, have negative spillover effects on other businesses, and prolong the recession through debt overhang and avoidable unemployment.
All of which is why—it bears saying again—we should not treat it as we would any normal recession.
Australia, a country that led the world in its fiscal response to the Great Recession—and managed to avoid a recession entirely and continue three decades of uninterrupted economic growth—has shown the way on dealing with the economic aftereffects of COVID-19. Their just-announced stimulus package focuses on support for small and medium businesses, in addition to direct cash assistance to families.
In the next two weeks, every Australian small and medium business will receive a check worth between $1,300 and $15,900. The government is covering half wages of 120,000 Australian apprentices working for small businesses until September. And the government is also offering immediate expensing of all capital investments up to $95,000 while allowing accelerated depreciation for existing investments.
This is exactly the right dual-approach to helping both affected workers and affected businesses survive the crisis.
On Friday Nancy Pelosi reached agreement with the administration on a first-stage stimulus package focused on medical support and the social safety net. Importantly, mandatory paid sick leave was paired with refundable tax credits for businesses to help them offset these costs at this difficult time. But we need to do much more.
In the next stages of the response, let’s hope Nancy Pelosi and Mitch McConnell follow Australia’s example and formulate a package that not only helps households struggling through the downturn but also ensures they have jobs to go back to once the contagion subsides.