The Covid-19 crisis has encouraged the reheating of a lot of old economic ideas. Governments need to come up with genuinely new solutions.
There are two classic responses to economic crises – print more money in general or have governments spend more money they don’t have. The nuclear option is for the government to increase its deficit massively and then print the money to pay for it.
Used in moderation, monetary and fiscal responses can work in smoothing the business cycle. Used in extremis the lesson from history is that for every successful Roosevelt-style New Deal response, many more governments end up by unleashing inflation and going into default.
That’s why in the current crisis – which definitely requires a radical response – we should be wary of talk of New Deals and the like. This is the current vogue in Britain but it’s difficult to see how building a few new hospitals and repairing some roads will seriously address the issues facing the country. This approach is based on the ideas of what worked 90 years ago rather than what could work now.
It’s difficult to see how building a few new hospitals and repairing some roads will seriously address the issues facing the country.
Modern New Dealers who advocate huge amounts of government spending also forget that when president Franklin D Roosevelt's New Deal started in the 1930s, US debt to GDP was a mere 16% and only reached 44% at the end of the programme. In 2019 US debt to GDP was over 100%, even before the Covid 19 crisis, which severely limits the scope for fiscal stimulus.
The starting point for some new economic thinking has to be an assessment of what is different between a modern economy and the type of economy that responded to infrastructure building in an earlier time. Western economies are now characterised by high dependence on consumer spending especially in the area of services, most of which is discretionary and has come to a complete halt as a result of the pandemic.
On top of this the western consumer most notably in the US and the UK is highly indebted so an uncertain outlook for jobs means they save rather than spend or in the worst cases borrow even more just to keep going.
Finally, in today’s globalised economy more consumer spending (assuming that a New Deal could achieve it) means sucking in more imports and does not mean exporting more of the high value capital goods and services that these economies specialise in.
What the Covid 19 crisis has exposed is that the structure of many western economies is a house of cards which the pandemic has blown over. The starting point for a response is to ask the following questions: is this style of service economy sustainable? How do we regulate personal indebtedness and what is the role of banks? Is the globalised supply chain economy in its current form still the future? Rather than investing in infrastructure purely for the sake of it (unless it is really needed) governments would do better promoting a new style of manufacturing based on 3D and artificial intelligence?
This need not be an anti-globalisation agenda but it should be a forward thinking globalisation agenda that takes account of the climate change costs of transporting everyday goods halfway across the world when the techniques for producing them cheaply and locally are fast becoming available. Banks with the expertise to lend to these new kinds of business ventures would play an important role. Unfortunately, the current discussion is mostly about New Deals based on 90 year old thinking about economics. Such strategies are bound to fail.
Brian Caplen is the editor of The Banker. Follow him on Twitter @BrianCaplen
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