Luis Garicano Keynote Lecture

The European Union's economic response to the COVID-19 crisis

On 26 May 2020, the Rafael del Pino Foundation organised the Master Lecture live on the Rafael del Pino Foundation website. entitled "The European Union's economic response to the COVID-19 crisis" given by Luis Garicano.

Luis Garicano is an MEP, Vice-President of Renew Europe and Spokesperson of this group in the Committee on Economic and Monetary Affairs of the European Parliament, member of the Center for Economic Policy Research. He holds a degree in Economics and Law from the University of Valladolid, a Master's degree in European Economic Studies from the College of Europe in Bruges, a Master's degree in Economics and a PhD from the University of Chicago. Luis Garicano has developed his extensive teaching career at the University of Chicago and London School of Economics, where he has been a tenured professor and professor; he has also been Director of the Center for the Digital Economy at IE Business School; he has also been a visiting professor at MIT and London Business School. He has also held positions as an economist at the European Commission and at McKinsey & Company.

** The use of the presentation that you will find at the end of this post is authorised as long as the source and author of the same is cited.


On 26 May 2020, the <strong>Rafael del Pino Foundation</strong> organised a conference by Luis Garicano, MEP and Vice-President of Renew Europe, entitled "The EU's economic response to the COVID-19 crisis. Garicano pointed out that pandemics are not something new in history. We have had them in the past. For example, the Plague of Justinian, which affected the Byzantine Empire and other parts of Europe, Asia and Africa between 541 and 543; the Black Death, which affected Europe and Asia; the Italian Plague of 1629-1631, or the Spanish Flu. The good thing about the Coronavirus crisis in this case is that physical capital has not been destroyed and losses in human capital are relatively small. This pandemic is also quite special for another reason. In a war, people are never asked to stay at home, nor is production voluntarily reduced. Quite the contrary. In the United States, for example, during World War II, women left en masse to go to work so as not to stop production. The virus has an interesting economic aspect, which is the idea of the externality. An externality occurs when you make a decision that has consequences for others, but you don't put a price on those consequences. Taking to the streets in an epidemic is a case of an externality that has an important cost. For example, when young people go out carelessly in the street, without masks, without worrying about infecting or being infected. But also, if you want to be protected, you can go in the opposite direction and say I'd rather catch it sooner rather than later, which can lead to people going out more. The point is that people do not internalise the cost of their actions. For that reason, confinement is imposed by the government, given the need to freeze the spread of the virus. This situation is producing an economic contraction. We see that supply is falling, that people who are not producing are staying at home. Because of this, demand falls, and this goes back to supply. In Spain, spending has fallen a lot, by 60% in domestic spending and 100% abroad. There are activities that fall a lot and others less, depending on the composition of demand. There is also a much larger impact in the form of capital outflows than in the financial crisis. Investment in poor countries has fallen a lot. The decisions that countries have taken to deal with this economic situation have tried to prevent it from becoming permanent, because people lose their income, companies get into debt and everything leads to a very strong increase in public debt. In Spain it will grow by more than twenty points of GDP, as the sharp falls in supply and demand affect incomes. If this situation lasts for a short time, it will be easy to manage; if it lasts longer, it will be a problem. The key to the exit lies in how much protection against the disease is maintained and how many people are exposed. In this respect, there are three scenarios. If the confinement ends in the summer, there is social distancing, less travel, teleworking and a controlled autumn flare-up, the economy will pick up in the second half of the year. The worst case scenario would be that confinement returns in winter and the rebound is not controlled. Then there would be another fall in GDP. But if the virus dies, then the situation will improve rapidly because everything will return to normal. The economic policy decisions being taken have clear objectives. If the disease is left to run its course, it is bad for health, but the recession is milder. If the disease is tackled, it is good for health, but the recession is deeper. With this in mind, the aim has been to bring down the economy to protect health and to have a V-shaped recession, as has happened in China. From there, a series of decisions have been taken, which are explained by three problems. The first is that the flow of income from households to businesses stops because spending falls. The second is that the flow of wages and salaries also stops. Finally, lending to businesses freezes. So the thing to do is to protect workers and their incomes, even if they are quarantined and stay at home. Secondly, the liquidity of businesses must be guaranteed. Third, the financial system must be supported so that it does not collapse. These are the actions that have been taken in recent months. The sectors where employment is most affected are construction, hotels and restaurants, arts and culture. In services, the effect on employment is smaller. And in primary industries and sectors that can operate with telework it is even smaller. The crisis has very different impacts in different countries depending on the economic structure of each country. In Spain, 70% of jobs cannot be done from home, due to the weight of commerce, transport, hotels and tourism. A country that has many such jobs is a country that suffers more. Spain is therefore the third most vulnerable country. The jobs that are retained the most are those with the highest incomes. Of the lower ones, almost none are retained. This is why the unemployment rate is higher in the low-wage brackets than in the high-wage brackets. In order to protect people, labour market measures such as sick leave, the extension of unemployment insurance, wage subsidies, employment protection measures such as ERTEs and mini-jobs have been adopted, because the aim is to maintain the link between the worker and the company. This reduces redundancies and allows the employment relationship to continue, but with the worker being paid from elsewhere. A second group of measures is designed to protect businesses, in particular transport and shops. What employers are asking for is help to pay taxes, rents, social security contributions. SMEs feel financially fragile; they only have enough money to stay closed for a month or a month and a half. The main measures in this regard have been loans, public guarantees for companies to access credit, tax breaks and tax refunds, even beyond what has been paid. The third response at the global level has been to help banks by providing them with liquidity so that they can support businesses with loans. This has led to much, much more access to credit. As far as the European Union is concerned, it has three lines of defence. First, there is the response of the ECB, which has been able to act very swiftly. Central banks have acted very quickly, with very radical measures. The UK even allowed the Bank of England to finance its government directly. The ECB cannot do that, but it is buying the debt that governments issue. Even so, this restricts the ECB's ability to finance governments, because the bank can only buy up to 33% of each issue. Moreover, the ECB has a second restriction, which is that in each purchase programme it can only allocate to each country a percentage equal to its share in the bank's capital. To overcome these restrictions, the ECB launched a new debt purchase programme for 870 billion, valid until December 2020. If this is not done, it could lead to a debt spiral that could lead to a terrifying crisis, because the member states have a lot of borrowing needs. The aim is to avoid the vicious circle in which high interest rates raise expectations in the markets of default and thus of an exit from the euro, leading to even higher rates being demanded. To avoid these problems, the ECB has created the pandemic purchase programme. The problem is that it is going to run out sooner than expected, because it is buying faster than it thought. Moreover, the recent German Constitutional Court ruling ties the ECB's hands quite tightly by asking it to justify its previous programmes. This makes monetary policy very uncertain. The second line is fiscal policy. Fiscal policies are national and coordinated, but because they are national there is a risk of redenomination due to a higher risk premium. There is also an asymmetric bias in fiscal policy, with some countries spending little and others spending a lot, so coordination is not very fluid. Moreover, the number of actors involved in fiscal policy in the EU makes coordination difficult. The Eurogroup has therefore taken a little longer to do three things: a European Investment Bank (EIB) programme to provide liquidity to companies, the European Commission's SURE programme to protect workers and companies, and the ESM to finance health programmes. The EIB provides 21 billion in guarantees for business loans, but this is small. The SURE is financed by Europe and lends to member states, although it is complicated by treaty obstacles. The EU cannot borrow much. It can only spend 1.16% of GDP, and one point more if there is an emergency. It is already spending it and it gets the funding from the markets with guarantees from member countries. As far as the ESM is concerned, this mechanism has plenty of money, but it lends it out with conditions. That is why it is considered a political stigma to ask the ESM for help. A special crisis ESM with very soft conditionality has been put in place to finance expenditure on direct and indirect costs of the pandemic. Spain and Italy refuse to use it because they want a recovery fund, without conditions, but it does not make much sense because there are countries that refuse. Moreover, joining the ESM has a stabilising effect on interest rates because the ECB can participate in it. This is what has happened with Cyprus. The third line of defence is a recovery and reconstruction plan. The northern countries reject this because they do not want to mutualise debt, and they are right to a certain extent, because they have no say in what Spain or Greece do with the money. The European treaties also make it difficult to achieve debt sharing, because of the obligation for the EU budget to be balanced and the ban on bailing out countries. With this in mind, Garicano proposes the creation of a European reconstruction fund in the form of loans. It would be financed by a joint EU long-term debt issue, the interest on which would be paid from new EU own resources. These would come from new green and digital resources.

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.