The five trade-offs of the crisis

April 19th 2020 - Edition #32

The world has never seen a crisis like this. Recent recessions were very different, and when there were similar catastrophes, the world was very different. This means we really know very little about what’s in wait for us. Except for five old and relentless trade-offs.

The first interaction results from the obvious fact that the epidemic itself creates very few economic impacts. Paralysis is the result of the measures taken to avoid contagion, like quarantines and social distancing. This implies a basic option between saving lives and saving the economy. Lock-up reduces infection but destroys productive relationships. As the disease evolves, the equilibrium changes and controversy surges.

On top of this, there is a strong coordination problem generated by a basic externality, separating private from public welfare. Infected persons suffer strong costs, being forced to containment, to build a general benefit, reducing infection. This imposes a strong State coordinating intervention, limiting personal freedom in the name of public good.

A third trade-off rises in the public finance sphere, when a boom in health expenditures coincides with a strong recession, reducing tax receipts. The emergency implies a large and unavoidable increase in deficits, which must be courageously assumed by government. It may be said that deficits exist precisely for imperative occasions like these; but the short-term calamity may compromise long-term sustainability of government finances.

Economic policy is dominated by another central compromise between emergency and balance. The virus creates a classical depressive downward spiral, menacing the survival of the whole economy. In order to avoid such a nightmare the recipe is simple: governments must put money in people’s pockets, supporting households and companies, both facing a drastic cash squeeze. This money distribution must be generalized, unconditional and, above all, quick, to avoid a general breakdown. But there are a host of political considerations recommending lots of checks and balances, imposing bureaucratic oversight, thus criminally delaying the support, rendering it useless.

The final trade-off is, in a sense, the combination of all the previous ones. How long can social containment be maintained? How long can the financial support of the economy be upheld? Ending the first too soon, the plague returns. Ending the second too early, the economy will die. Ending either of them too late, the financial costs are unsustainable. Sooner or later we have to start using smart containments and smart supports, targeting only the infected who need quarantines, and the persons and companies who really need and deserve support.

João Luís César das Neves
Full Professor
Católica Lisbon School of Business and Economics

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