Keynote Lecture Juergen B. Donges

Summary:

On 20 May 2020, the Rafael del Pino Foundation organised a lecture by Juergen B. Donges, Emeritus Professor of Economics and Director of the Institute for Economic Policy and the Otto Wolff Institute for Economic Studies, both located in Cologne. Donges, Emeritus Professor of Economics and Director of the Institute for Economic Policy and the Otto Wolff Institute for Economic Studies, both located in Cologne, entitled "Coronavirus and economy: common and unusual challenges". Donges pointed out that the current economic crisis, which we have at national, European and global level, eclipses any other we have known before because of its origin, its depth and the difficulty of foreseeing when it will bottom out and recovery will begin. The crisis is completely different from previous ones because it has not been caused by economic policy failures, but by a pandemic that is still difficult to tackle. Although in some countries the curve is starting to turn favourable, the epidemic remains. No one knows for sure how long it will last and whether a new viral wave may arrive before we have an effective treatment or a vaccine. In this context, economists believe that companies and workers will have to live with Covid-19 for a long time to come. The pandemic has generated two simultaneous shocks: a supply shock and a demand shock. The supply shock is that global value chains have been disrupted by the measures taken to halt production activity and by restrictions on imports and exports of many products. In the EU, the Single Market has been dissolved, while protectionism has increased in the global market. The demand shock is due to the fact that the authorities' measures have severely restricted the mobility of people. This has adversely affected household spending on consumer durables, leisure and tourism. Air, sea and rail traffic have been depleted of passengers. Both shocks are already having an impact on the world economy in the first half of the year. All advanced economies are in recession, facing bankruptcies of SMEs and the self-employed, sectors such as airlines are struggling for survival, massive job losses are occurring, public debt is rising. And what has been lost so far will not be recovered. Global GDP will fall by 3% in 2020. In the Great Recession the fall was 1%. World trade has plummeted by 11%. Recession is widespread in all advanced economies. Emerging economies are expected to see a smaller decline than advanced countries, with activity falling to 11 Q3GDP. For China and India, growth is forecast to be moderate and well below the historical average. For Brazil and Mexico the outlook is for a sharp contraction. If these IMF forecasts are confirmed, we would have a V-shaped economic development. The assumption is that the pandemic will clearly subside by early summer and that there will be no significant resurgence, that the health measures can then be lifted and that the fiscal policy measures will work. In this case the recovery would start in the second half of the year and continue into 2020. But there is no guarantee that this scenario will be fulfilled. Things could get worse. A first scenario, in this case, would be a U-shaped cyclical profile, with a longer lower base if the pandemic lasts longer with upturns. This would delay recovery until well into 2021, with very low growth rates. Spain could be in this scenario. The second scenario corresponds to a cyclical L-shaped profile, without being able to determine the length of the base. If a new wave were to occur, activity would be restricted without seeing the light at the end of the tunnel. This would be a real disaster for businesses, workers, the public purse and social security. The probability of the crisis profile being V-shaped is 60%, U-shaped is 30% U, and L-shaped is 10%. But it is all shrouded in enormous uncertainty. The profile of the recovery will differ from country to country. The starting point of the recovery will be more or less complicated depending on the measures taken beforehand. Countries that have paralysed the entire economy, such as Spain or Italy, will have a harder time than those that have maintained production, albeit on a smaller scale, such as Germany or the Netherlands. The weight of the hard-hit sectors in GDP also plays a role. It is now a question of reconciling health and economic objectives. As long as the risk of contagion has not disappeared and there is no effective vaccine, it is right to take extreme precautions. But it is also right to start de-escalation if the number of infected people evolves favourably. Saving lives is very important, but it is not the only thing to think about. Policy makers will therefore have to walk a razor's edge when weighing two objectives: saving lives and saving the economy as a source of jobs and welfare. If they focus only on the pandemic, subjecting citizens to restrictions on their mobility and activities for an indefinite period of time, they may cause great collateral damage in the form of hunger, family disruption, growth problems for children, etc. Governments, however, have tried to respond in the best possible way to this dilemma. The health and economic challenges have to be reconciled. On the health side, it is crucial to learn the lessons from the current phase of Covid-19. We need an early warning system for all risks of new viral alerts to contain it. We need a comprehensive network of high-level clinical diagnostic laboratories. We need intensive medical research on infectious diseases, their treatment and how to curb their spread. We need an adequate health reserve in terms of staff, medical equipment, protective materials, hospital beds, tests, ... We also need a coherent policy concept, based on scientific evidence, with reliable and objective data, without relieving governments of their responsibility for decision-making on the shoulders of experts. In the event of a resurgence, the current de-escalation processes must be suspended immediately and measures to contain the virus must be introduced. Finally, much clarity and transparency is needed to convince citizens of the need to comply with the rules. Without trust in the institutions, public appeals to citizens will be futile. Strong coordination between European authorities rather than unilateral action would also be advisable. The economic challenge is twofold. On the one hand, we must avoid an irreparable deterioration of the productive fabric, without blocking structural changes that arise for technological and market reasons. On the other hand, the confidence of economic agents must be restored in order to revive the economy. In macroeconomic policy, the key now lies in fiscal policy. Central banks will maintain an ultra-expansionary monetary policy, so that financial conditions will remain very loose. Governments have done what they had to do, which is to urgently provide liquidity to companies and the self-employed. The aim is to avoid layoffs and bankruptcies because if there were too many bankruptcies there would be negative effects on the banking sector. Among the measures adopted are non-refundable subsidies to curb fixed costs, guarantees for bank loans, reduction of contributions, public benefits for redundancies such as ERTEs, and tax deferrals. Governments have generally acted in this direction. For fiscal policy it will be important to know in which cycle we are going to move. If the profile is a V, the measures adopted, together with the operation of automatic stabilisers, provide sufficient support for activity. No more should be done, as this would be over-action and would be counterproductive in the medium term. If the profile is a U or an L, then more fiscal support would be needed. The most effective way is through tax relief for companies, including accelerated depreciation, by carrying forward losses to previous years in which profits were made, and by promoting public investment in education, research, health and vital structures. It is also necessary to cut red tape for business start-ups. With consumption, it is not clear whether we need fiscal stimulus or not. The current evidence is that shops are attracting customers again. So there is consumer spending. But we also see a certain timidity on the part of consumers to increase spending on durable goods. In this case, there is room for fiscal stimuli, in particular a temporary reduction in VAT. But we must be wary of generous subsidies or capital injections for certain companies. Such aid is questionable. Moreover, supporting some means discriminating against all others. This distorts competition, creates inefficiencies in factor allocation and, in the end, the cure may be worse than the disease for the economy. Governments may also need external assistance. In Europe they can avail themselves of the mechanisms we already have, which are well endowed and whose access conditions have been relaxed: ESM, structural cohesion funds and the European Investment Bank. Governments can already take advantage of all this. Setting up a European restructuring fund would take a long time and many countries would not agree. That is also why there is no need to return to the issue of Eurobonds, because there are three problems. One, reforming the EU treaty and abolishing the bail out clause. Two, it means mutualising public debt by law, which creates perverse effects because countries would not apply rigorous budgetary policies and would delay the structural reforms necessary for economic growth. Three, Germans having to take responsibility for other countries' debts without having any influence on how and in what the debt is used is unacceptable. It would be a different matter if all countries were to relinquish their national sovereignty in budgetary matters to EU institutions. But no progress is being made on this because countries are unwilling to give up their sovereign competence. With this crisis, deficits and debt-to-GDP ratios will increase. We have two different scenarios. There are countries like Germany, Austria or the Netherlands that have balanced public finances because they have done their homework in the past. These countries will find it easier to take on the growing debt. Other countries, such as Spain, which have not known how to or wanted to use the economic boom to implement a more rigorous fiscal policy, will find it more difficult. What is important to know is that, for the time being, under the rules of the Stability and Growth Pact, there is no limit to increasing deficits and debt. But this is temporary. When the crisis is over, countries will have to prioritise budgetary consolidation because it is unsustainable to maintain very high levels of debt. More or less severe economic adjustments will have to be made on the side of inefficient and unproductive spending. If we manage to get the rate of economic growth to exceed the interest rate, the adjustments will be more bearable. There are other things that will also have an impact on this challenge. One is the reinstatement of the European Single Market and the Schengen Agreement. Once de-escalation has begun, it is unreasonable to perpetuate border restrictions that would ultimately be detrimental to all. Two thirds of the EU's external trade is intra-European trade. Without complete freedom of trade and movement of people, much of the potential for growth would go untapped. Economic revival also requires entrepreneurial action. This is not the time to propose the nationalisation of companies and take advantage of the current crisis to advance the ideology of an extreme left-wing ideology. Public companies are not profitable, are very costly for taxpayers and are holding back growth. Nor is this the time to cut back on economic globalisation and resurrect models of national autarchy. They would impoverish society. Modern history reveals that the freedom of private initiative exposed to intense competition in national and global markets is the driving force of innovation which, in turn, drives economic growth and job creation. As we emerge from this crisis, it will be evident again. The coronavirus may eventually become an accelerator of digitalisation. In recent months we have already tested the possibilities of teleworking, videoconferencing, videoconsulting, e-learning, etc. In the future, face-to-face meetings will continue to be important, but companies and young entrepreneurs will not give up the application of this technology. New technologies eliminate the importance of the distance factor. The immediate economic future will be characterised by a pandemic economy. But with the right policies it will be possible to relaunch activity and put it on a path of sustained growth, albeit at a lower profile than in recent years. A sine qua non condition is a return to the rule of law, which has been eroded of late. Without it, the economy cannot function. Some countries have resorted to declaring a state of emergency, which gives the executive absolute power and circumvents parliamentary control. This is very worrying and has to stop. For the sake of democracy and a well-functioning economy, it is essential that political leaders resist totalitarian temptations without restraint.

The Rafael del Pino Foundation is not responsible for the comments, opinions or statements made by the people who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their sole responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio González, are the result of the debates held at the meeting held for this purpose at the Foundation and are the responsibility of the authors.

The Rafael del Pino Foundation is not responsible for any comments, opinions or statements made by third parties. In this respect, the FRP is not obliged to monitor the views expressed by such third parties who participate in its activities and which are expressed as a result of their inalienable right to freedom of expression and under their own responsibility. The contents included in the summary of this conference, written for the Rafael del Pino Foundation by Professor Emilio J. González, are the result of the discussions that took place during the conference organised for this purpose at the Foundation and are the sole responsibility of its authors.

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