Everybody understands that an economic downturn will follow the pandemic. Economic forecasts that started as relatively mild ones now often turn towards apocalyptical. No one is surprised by the Bank of Lithuania‘s reevaluation of its forecasts, that claims the downturn could reach 20 per cent. Similar numbers are being put forward by the US and German experts.
The famous ex-President of the European Central Bank, Mario Draghi, has said that the “Coronavirus pandemic has the potential to be a tragedy on a biblical scale”. Many are in danger of losing their lives, but many are also in danger of losing their normal way of life and economic foundation.
It looks like this time the economic crisis on a biblical scale will be solved with a ‘flood’ of money on a biblical scale.
Trillions in financial resources are being mobilized by the US, EU, Germany and others. Various schemes are being developed to decide how this money will be raised and used.
This crisis differs from 2008-2012 financial crisis in that this time even the European Union (EU) is planning from the very beginning to ‘flood’ the affected economies with substantial financial resources. Last time, the EU started doing this only in 2012 after the famous speech by Mario Draghi that calmed down the markets. It looks like there will be no shortage of liquidity to tackle this crisis.
The core question is this – will that money be used smartly and effectively, and will we not have a situation where countries are drowning in huge debt (Lithuania’s debt could grow from the current 35% of GDP to 50% of GDP) and despite that, – significant parts of the business will be either struggling with debt or already going bankrupt.
It is therefore very important how these massive financial resources will be used, how they reach the economy, and how they help the business to weather the crisis. Schemes that will guide how the money is used are being considered and adopted. We can easily name a few of the more notable examples.
The US is planning to give every person, who prior to the pandemic earned less than 75,000 dollars per year, a one-time payment of 1200 dollars. This scheme was called ‘helicopter money’ by Martin Friedman in 2012 because this money would reach the person without any intermediary institutions as if a drone or a helicopter would bring that money to their homes. A bit later, I will discuss why, in my view, using money in this way would currently be ineffective.
The Lithuanian government is also announcing the known support mechanisms for businesses: government subsidies for paying wages during business’ inactivity period, tax holidays and cheaper loans. To finance this, the country plans to borrow up to 5bln Euros. Prime Minister and Finance Minister warn that only business that retains workplaces will receive the support. The business community complains and fears that this support will not be sufficient, and is already firing employees or is preparing to go bankrupt. Economist V. Navickas suggests that business should be given a ‘rent and credit holidays’ to make sure that fixed costs do not push the business into bankruptcy or leave it with unsustainable debt. However, the real estate sector sees these suggestions as detrimental as it doesn’t want to shoulder the financial burned of the pandemic.
It is precisely in these circumstances when promises are being made that there will be sufficient flow of money, it is worth stopping to consider which philosophy should be employed to tackle the crisis and make the best use of the funds available.
About the scheme to tackle the crisis
It is quite obvious that the current crisis differs from the financial crisis of 2008-2012. That period saw the collapse of major banks, the closure of financial markets, the inability of states and businesses to access credit, business suffocating without financial lifelines, and a wave of bankruptcies.
In this case, the problems are different. Completely healthy businesses are forced to close due to quarantine because that is the only way to tackle the pandemic. The closed businesses no longer receive their usual income and, unless it can envision its long-term perspective, it may end up announcing it has gone bankrupt. To better outline that long-term perspective, first, it is essential to name what problems the business is likely to face in the near future. These can be problems that differ from business to business, which is why the government support has to be tailored to different groups and be based on different philosophies.
Without going into too much detail, it is possible to outline three separate business groups, which will experience different problems and which need measures tailored to their situations.
I conditionally outline three business and problem groups:
a) A business, with “prohibited supply to the market”, that is simply closed due to fall in demand, following the announcement of state-wide quarantine. These businesses have no choice but to close and they include food outlets, hotels, beauty salons, recreational and culture services. “Euromonitor international” stated that in Lithuania this encompasses around 268,000 places or 20% of the workforce. These businesses no longer receive any income, because its products or services offering has been completely shut down.
b) Companies with demand postponed or delayed due to the quarantine. Upon announcing the quarantine, income is lost not only by those businesses that simply closed but also by those who serviced a demand that drastically fell. Those who planned to buy a car, furniture or a new suit in April will not do that, because they don’t want to visit places where there may be a lot of people. But such a customer will still buy these products once the quarantine is lifted unless he loses his currently available money in the meantime.
c) The uncertain state of foreign markets. There is a lot of uncertainty in all markets. Businesses specializing in exports is worried not only about the current prognoses, but also longer-term future global market trends.
If we compartmentalize the business problems in such a way, it is clear that group b) and c) business problems will be less painful than those of the group a).
Of course, trying to forecast the direction and length of the pandemic in Lithuania is a futile exercise. However, in the context of this article, we will assume the opinion of experts that the pandemic will last until the end of May.
In that case, it is clear that at the beginning of July the “postponed demand” of the b) group can turn into a post-quarantine boom when there is a rapid rise in consumption of cars, furniture and other non-essential products. That is why these businesses need only temporary support. Firstly, this should include tax holidays and, maybe, easier access to loans. This is all because there is a high probability that when this crisis ends, a sharp rise in demand will compensate for the “postponed demand” period.
It is difficult to help business that makes up the c) group, those that sell their services or goods in the export market. These markets are currently unstable, and businesses of this type depend on the state of export markets. We can only console them that governments of other major markets, such as Germany and France, are announcing big economic support programs that could help retain the demand for products and services from Lithuania.
On the support philosophy for businesses that have shut down during quarantine
Now all that is left is to discuss the a) group which has simply shut down during the quarantine. This is done to reduce social contact between people. We can remind ourselves that food establishments, hotels, beauty outlets, recreational and cultural services are almost entirely shut down at this point.
Earnings of such businesses are practically zero, and it is also possible that once the quarantine is lifted, people will continue to avoid congregating and will not return to restaurants, cinemas and gyms for some time. There is also a high probability that this summer the pandemic will calm down only temporarily, only to return in a year. In other words, the quarantine may be renewed at a later date. The businesses are forced to consider this when planning their future.
It is this group that needs government support and care during the crisis, which is built on an understanding of the problems and the type of support that is appropriate.
We must first clearly state that the problems this group’s faces are not self-inflicted. Many have led healthy and successful businesses, enjoyed sustainable demand, were not in deep debt and did not spend unnecessarily. Their problems come from the fact that quarantine is currently the best way to tackle the pandemic. The government enacted quarantine (which was the correct choice). However, there are multiple consequences that we now face.
On the one hand, people are being protected by the quarantine, and helping people avoid loss of health is a shared concern. On the other hand, many businesses that make up the group a) are experiencing huge losses. Society should be interested in helping them not experience further losses that exceed the average loss of the whole economy.
Here we have the core of the problem: how do we help the a) group effectively and appropriately. Government’s proposals so far – wage subsidies, tax holiday, easier loans – are good. However, that is not enough, because businesses also have fixed business costs, such as rent and loan payments. To avoid a debt spiral, businesses cannot pay these using new loans, even cheaper ones, and original property owners may refuse to agree to defer rent payments. Besides, such support is tied to businesses retaining workplaces for a long time and under any circumstances. If it fails, the government is threatening to punish for such unfair behavior (which is a strange threat to a business already scared by the crisis!).
These businesses are currently without an income and are experiencing losses only because of the quarantine, introduced for the benefit of the society. Their possibility to supply their services or products are currently ‘closed’. In this case, the government should act in the same way it acts when it takes over private property for reasons of national importance. In that case, it needs to buy it out, covering all the losses of the current owner. During the wartime, Germans, when requisitioning for military needs the horse of a Lithuanian peasant, would give him a debt note. Now we are at war with the pandemic. For that purpose, businesses are being closed in government’s name (they are temporarily requisitioned). In this case as well, for purposes of public interest (war with the pandemic), the government enacts quarantine, and because of that, some businesses are closed. Therefore, the government itself must find a way to compensate the businesses for the losses they experience. Compensation should be at least big enough to ensure the losses do not exceed the average loss of all other businesses.
A simple idea comes up from this – why can’t this business receive a ‘quarantine package’ from the government, a type of support or subsidy that would compensate it for the losses experienced due to the quarantine. If that were the approach, you wouldn’t have to spend time deciding what share of the subsidy should be spent on wages, and what should the business do about the fixed cost expenses, that is, whether to ask for a cheap credit or a delay of payments. The government then wouldn’t have to threaten businesses that received this subsidy to retain workplaces. This threat alone shows that the government’s philosophy is unsuitable for the situation. It thinks it can show ‘benevolence’ during the quarantine and help a little bit, but with terms and conditions attached (by the way, same conditions were announced simultaneously by Prime Minister of Russia, Michail Mishustin).
Meanwhile, government’s constitutional responsibility in relation to these businesses is to compensate for the losses they experience during quarantine simply. It could do this by promising each business a ‘quarantine package’, a subsidy that would ensure that during the quarantine the business has 80% of the income it had before the quarantine. The subsidy could be reduced in line with the fall of the country’s GDP. When it gets the subsidy, the business itself could decide how many people it should retain and how should it handle its ongoing expenses.
Such a government subsidy could reach every business as a Lithuanian model of the ‘helicopter money’. ‘Helicopter money’ – for the businesses, not people, at least at the starting stages of the quarantine. If such money would be given to individuals and raise their buying power, as a result, it wouldn’t solve the main problem: the crisis is starting not due to lack of demand or buying power, but due to businesses being unable to offer its products and services. If we want to solve this problem in a targeted way, the money has to reach businesses in the a) group, which are closed for our benefit. They are sacrificed or are sacrificing themselves, for us, and it would be unforgivable if we fail to help them survive.
This ‘helicopter money’ for businesses closed due to quarantine could become an EU broad instrument. In addition, a targeted approach would outperform the solution by the US to already give its individual citizens’ helicopter money’. This type of support may be needed, but only after the quarantine is lifted and when the same restaurants, gyms or beauty salons start needing higher demand.