Here’s a potentially unpopular proposition: The bulk of government economic action over the next few months should be directed to keeping businesses alive.
Specifically, we need to keep afloat the many businesses with coronavirus-related short-term cash-flow problems.
The correct lever to pull here is not “consumer stimulus” but “business lending”.
The UK government is already doing this, and there are signs that Australia’s government is moving this way too. And to the extent they do, they need to be supported.
Flattening the economic curve
Governments are rightly trying to “flatten the curve” of coronavirus infections through various mechanisms, but particularly “social distancing” – discouraging face-to-face social interactions.
That presents an economic dilemma: the more they succeed in this effort, the more businesses are headed for trouble. Many businesses just can’t run on ecommerce and working from home. Airlines, sports teams, entertainment venues, restaurants and most manufacturing businesses spring to mind. The UK airline Flybe has already collapsed.
The economist John Cochrane has spelt out how this would happen:
“The store and factory may shut down, but the clock still ticks. Businesses must still pay debts, with nothing coming in. They likely have to pay wages – otherwise, what will people do to buy food? People have to make mortgage payments and rent, likely with no income coming in. Left alone, there could be a huge wave of bankruptcies, insolvencies, or just plan inability to pay the bills.”
So the economy could well soon be full of businesses that are short-term insolvent, with too few customers and too few employees, even though they are medium-term viable.
And note that this could happen even if the government sent a lot of checks to sacked employees sitting at home, or if it cut or delayed a lot of payroll tax payments. We’re not talking about revenues dropping five or ten per cent; we’re talking about them dropping by 50 per cent or more for some firms. These businesses won’t just need a little bit of a pick-me-up; they’ll be on stretchers for a while.
The argument is that governments will need to spend most of their economic policy efforts keeping these businesses alive. In other words, they need to flatten the economic curve.
Supporting banks to lend
The best vehicle for that is probably bank guarantees – that is, what Obama did for GM, but on a bigger scale, and arguably with better justification.
This isn’t my invention, though it chimed with me as soon as I saw it. The case has been made best since early March by the economists John Cochrane and Po Gourinchas, working – as far as I can tell – completely separately.
Cochrane makes his case in Chapter 12 of a quickly-published volume edited by Richard Baldwin and Beatrice Weder di Mauro, called “Economics in the Time of COVID-19“. It’s a great effort, aimed squarely at the question “What can governments do about the coronavirus?”
Cochrane argues that if this was a two-month holiday which we could plan for ahead of time, things would be much better. The heart of the problem is that the coronavirus struck us unprepared. In particular, we don’t have cash to see us through the necessary social distancing period.
This means that firms – a lot of firms – are going to go bust unless we do something. Essentially, we need to keep most of them alive so that we can “turn the economy back on again” when the coronavirus threat abates. Too many bankrupt firms, and that won’t happen.
His solution is fairly simple: governments need to subsidise banks to avoid foreclosing. Here he is in conversation with Bill Whalen at the Hoover Institution’s Area 45 podcast, making the case:
“With some subsidized lending, you want to synthesise what what would have been a pandemic insurance contract: you pay a premium, and you get some money in bad times. So by making it borrowing that you have to pay back, as opposed to just a gift, then you get people to sign up who really need it, and then you can get more money where it’s really needed, and less money where it isn’t …
“You’ve got to try to get enough money to the right places so that people aren’t horribly hurt – that sort of insurance function of government – so that businesses are still alive and ready to go when it’s time to go. That’s why I like the idea of lending, possibly somewhat subsidised lending – it has to be.”
Cochrane is a right-wing economist, but note here that he’s arguing for sweeping government action.
Pierre-Olivier Gourinchas makes almost the same case in “Flattening the Pandemic and Recession Curves“, published on 13 March. He invented the term “flattening the economic curve”. He wants to keep alive viable business which this short but very sharp downturn would kill. And for a short-term business cash-flow emergency, it seems to me that short-term loans are exactly the right remedy.
Gourinchas in particular says the flip-side of this deal is that firms keep most of their workers employed, so that they in turn can pay their bills.
But we may need a very large pile of loans to make this happen. Much of the government’s effort may need to go into making sure the loans keep flowing. That will have real budgetary costs in the medium term. Just as in 2008, money will go to the wrong people. As in 2008, we will just need to cop that.
The stimulus trap
I’ve previously argued for “stimulus” myself, because I hadn’t thought through the economic implications of large-scale social distancing the way Cochrane and Gourinchas have.
This episode is very different from 2008, and needs very different responses.
The idea that more support needs to go to propping up businesses – far more than in 2008 – won’t be popular, especially on the left. “Stimulus” has become some people’s answer to every problem.
But how much stimulus do you need to get a roll of toilet paper in Australia right now? How low does the interest rate need to go to support a business with $1 million of monthly expenses and no income? “How much stimulus” is the wrong question this time.
2008’s problem was “consumers won’t buy”, and stimulus was a viable answer. 2020’s problem is shaping up to be completely different: consumers can’t buy, because the businesses they bought from have gone under. This slowdown was a supply shock before it was a demand shock.
So our priority must be to keep businesses alive through lending, as the UK government seems to be doing, and as the Australian government seems to be preparing to do.
Tell me why I’m wrong.
Thanks to Nick Gruen as well as the cited authors for helping me to think through these issues.
Appendix: What’s worth reading and listening to
- Economics in the Time of COVID-19, especially chapter 12 by John Cochrane (but the intro chapter is good too)
- Flattening the Pandemic and Recession Curves by Pierre-Olivier Gourinchas
- Area 45: Cochrane: Is An Economic Stimulus The Right Cure For The Coronavirus? (source of this article’s Cochrane quotes)