Saturday, 11 April, 2020
As the COVID-19 crisis unfolds, the economic implications are deepening. Disturbing reports of rising unemployment have sadly become commonplace in recent weeks.
A recurring observation by economists and officials is that the COVID-19 crisis has different economic implications than the global financial crisis (GFC). But what does that really mean?
As many of us know, the GFC began with the collapse of the US housing market. As the crisis escalated, households attempted to bring down their own levels of debt. This decline in household spending saw US economic activity grind to a halt as demand for goods and overall spending by the community sharply declined. Remember: one person’s spending is another’s income.
What started as a ripple ultimately turned into a tsunami that rolled across the entire globe.
We are facing another global economic shock spurred by COVID-19 – but the nature of this crisis differs from the GFC in two important areas.
First, the global economy is absorbing this shock from a less than robust base because many countries and households are still recovering from the GFC hit in 2007-08. That includes Australia as evidenced through the country’s persistent underemployment, job insecurity, rising wealth inequality and stagnant household consumption. More startling is that many countries within the Eurozone, including in Greece, Spain, Portugal and Italy, have not recovered from the GFC at all.
The second point of difference is that, through COVID-19, the global economy is feeling the combined effects of shocks to both supply and demand. By contrast, the GFC was primarily a ‘demand’ shock. Households and industry pulled back on consumption, and the economy suffered as a result.
Under COVID-19, demand for some goods is thriving to the point where supply cannot keep pace – think medical supplies and basic household items (toilet paper, cleaning products, pasta, etc.). Compounding this supply shock is that production worldwide has slowed significantly as a result of lock-downs of whole regions and countries – the World Trade Organisation has estimated that global trade flows will contract by 32%. (Source)
Unsurprisingly, economic uncertainty means that most people are also holding back their spending on ‘non-essential’ items until we are in safer waters. So, on the flipside of the supply shock, we are facing a reduction in demand for many goods and services, and that demand is what keeps the economy strong. Notably, history tells us that austerity does not work as a response – failing both during the Great Depression and in the aftermath of the GFC. While an inclination to sharply pull in our belts is understandable, it spells a potential increase in the duration and intensity of economic pain.
The swing of the pendulum between these supply and demand shocks needs to be balanced as quickly as possible to recalibrate the continuum and minimise the economic hit. That is what governments are working feverishly to address. The challenge is to fill the gap in aggregate spending and generate confidence to encourage broader, more sustained economic activity.
Our saving grace will be for the Federal Government to spend, and spend big for a prolonged period.
The Federal Government’s recent stimulus packages are a strong step in that direction, but will it be enough? The Rudd government injected around $40 billion in its initial response to the GFC. Given the current state of the Australian economy – with 50% of Australian businesses already reporting adverse impacts during March (Source) – a direct fiscal response is imperative, and that is what we are seeing, including this week’s welcome instalment of a $130 billion wage subsidy.
In designing and implementing the stimulus, a first priority has been a sugar hit through large cash injections to households and tax relief for businesses. Although both are helpful, such measures will only be effective if these dollars are channelled back into the economy through spending rather than pocketed to safeguard against an uncertain future. Our economy will only thrive when firms are hiring staff and investing in new assets. But hiring and buying will not occur without direct, sustained cash flow support to households over the longer term, as it is household demand for goods and services that underpins strong economic activity.
Admittedly, we are only at the start of this economic crisis, and the playbook is unwritten. Balancing the budget as the prevailing mantra has been parked for now as the Government throws as much as possible toward keeping the economy moving.
Yes, the path ahead is unknown. One certainty is that the effects of prolonged lock-downs will continue to reverberate across every home and business for months – and possibly years – to come. This recast future compels governments and indeed all sectors to rethink their approaches to sustainable economic management and growth.
George Pantelopoulos, Researcher, HRF Centre
11 April 2020