GFC vs Covid-19

It is said that generals fight the last war. In the case of the early stages of the Global Financial Crisis (GFC) they had learned from the Great Depression of the 1930s and they fought intelligently and successfully. Later their advice would be ignored in favour of the Austerians who used the crisis to pursue their ideological objectives of diminishing the size and scope of the state (an odd thing to do, given that the GFC was a failure of the private sector).

So perhaps it is not surprising that much of the commentariat’s approach to dealing with the economic disruption from Covid-19 was based on the GFC. Yet the two are economically quite different.

The GFC was about the breakdown of the monetary system. When that happens the economy loses its means of payment and it stalls. But in the case of the Covid-19 disruption, the monetary system has remained largely intact. Instead, some important sectors of the economy cannot function because mobility of persons has become very limited – in two major ways.

First, there is the need for social distancing and social isolation to slow down the spread of the virus, reducing the peak pressure on healthcare facilities (while lengthening the time of significant virus activity). This is generating a lot of social disruption. That also applies to economic activity. Some businesses are finding it hard to maintain production because their workers have to be isolated, while others – in domestic travel, events and hospitality – are facing severe reductions in demand.

The restrictions and guidance will get tighter, but when they are relaxed – probably not before July at the earliest – any longrun effects may be minor. Some businesses which were marginal will have closed while perhaps more positively, the practice of working at home will continue where it proves more successful than expected.

Second, there are the consequences of our international isolation – making it more difficult for people to cross our borders. This especially impacts on the tourist and hospitality and the international education sectors and on those dependent on temporary migrant labour. Because Covid-19 is likely to be hanging around overseas for quite a while, these sectors are likely to suffer for considerable longer than a few months. Possibly some will suffer permanent change; I do not see a significant cruising industry until there is widespread availability of the yet-to-be-developed vaccine.

There are some other effects. The world economy was probably already entering into a recession, there will be some disruption in supply chains but perhaps not for very long (forestry is at the beginning of one; paracetamol at the end of another), while the sharemarket is in hysterics. (I do not give as much weight to share prices as do sharebrokers and shareholders or journalists who like it because it is a real-time indicator – but of what?) We could have handled such things reasonably easily by themselves (providing we kept the Austerians out of the main decision loop). Covid-19 makes it much more difficult.

It follows that GFC policy responses would not have much traction. Those in the commentariat were calling for an interest rate cut were doing so before the virus disruption and no doubt will be doing so when it is over. The same for those who advocate tax cuts and suspension of the minimum wage hike. Circumstances change but their policies do not.

Of course the Reserve Bank has to make its contribution but this time, unlike in the GFC, it will not be doing much of the heavy lifting. That will be carried by the Treasury.

The Minister of Finance announced a major business relief package on Tuesday (17 March). He promised more. And one may expect more fiscal tuning in the May budget (which may be presented with everyone wearing masks).

Besides the concern about whether some of the measures can be delivered – we have a very run-down public service which may be overwhelmed when it has to implement the measures – some will be concerned at the size of the fiscal injection. At about 4 percent of GDP this year, it is said to be one of the largest set of measures in the world relative to the size of the economy, The prime minister described it as the ‘largest peacetime government spend in New Zealand's history’.

I haven’t seen the detailed calculations so I shant join the commentariat in making off-the-cuff assessments. But I will say this. This columnist has repeatedly cautioned against excessive public spending and tax reductions in prosperous times, arguing that we should keep debt to a prudent level so we have room to manoeuver in times of adversity. What I had in mind was another GFC or a shock like foot and mouth disease or a major earthquake. I did not contemplate a pandemic (the Ministry of Health did). Yet I have no doubt that this is one of those, hopefully rare, occasions when it is prudent economic policy to do a big fiscal injection. This is a different war.