Abnormal times, abnormal policies
John Maynard Keynes, one of the most influential economists of the last century, laments the indecisive response of policymakers to the Great Depression by quipping “in the long run we are all dead”. The present day policy makers cannot afford to ignore these words if they want to craft a response that is effective in the short run and sustainable in the long run.
The uniqueness of the present circumstances stem from the many-sided tradeoffs e.g. between the short run costs and long term benefits. At the same time economic activity need to be stimulated not only from the top down but also from the bottom up. Given the demand driven nature of macroeconomic equilibrium in the short run, the relative importance of the later excels the former.
The critical dependence of private investment on consumer spending means that it remains sluggish if consumers keep their gloom. So no amount of incentive packages or interest rate cuts are likely to kick start the economy (at least this is the lesson from the Great Recession and Japan’s lost decade). The logic is plain: Businesses invest only when they expect high demand, high revenues, and high profits. The present business conditions are offering low costs as far as interest rate costs are concerned but don’t offer much prospect in terms of demand and profits in foreseeable future. On the other hand, the petrol price hike and the hasty it is announced and implemented has increased the impression of government being serving vested interests.
In these circumstances, the policymakers need to take bold steps. One possibility is the top-down approach. For instance, the top down approach recommends focusing on small business that rely on bank finance. The already reduced interest costs can be buttressed with tax concessions on new (physical) investments; concessions for women entrepreneurs; and businesses that promise greatest employment generation. Similarly, the small and medium enterprises need re-orientation perhaps through basic training in IT skills and free fast internet connection so that they can exploit the huge gap in the demand of online business solutions and their supply. An awareness campaign may help small entrepreneurs see opportunities in difficulties.
As the worse of the COVID-19 crisis is yet to come, we cannot rule out the possibility of lockdowns few months down the road. It has been argued that lockdowns are killing informal workers. This cannot be denied. An ideal economic policy in this context is one that saves lives, break the neck of COVID19, generate economic activity, while also saves the livelihood of the informal workers from the bad effects of lockdown. Can we have such a good economic policy?
A possible strategy is to use the vast commercial banking network to register informal workers by offering them free loans (in the form of bank deposits). In contrast to government’s c-ash transfers the policy proposed here has two goals: formalizing work force; and give them a credit line to generate their own income.
This policy along with the stimulus package for the construction sector that the government has announced will exercise multiplier effect through government spending, consumer demand and investment spending. From the top, the government should start big development projects to boost the confidence of construction sector. It would accelerate both the capital formation and expand jobs. The workers should be hired through formal contracts (with reasonable safety conditions) and are required to be paid formally through bank transfers. In this way, all the transactions are recorded formally.
From the bottom, the availability of free loans increases the aggregate demand in the economy and especially for the items demanded by middle- and low-income groups (mostly local manufactured). It will increase the profits of local businesses producing these goods and change the future outlook.
It is important to highlight the role of modern commercial banking sector in this scheme. Surprisingly for many but realistically indeed, the credit creation in modern banking don’t require any prior asset to create IOUs (i.e. deposits). They only need a promise to payback from the borrower. And government assurance can make many such promising borrowers possible currently working in the informal sector.
Another significant advantage of this policy is that it will formalize all the informal workforce in Pakistan. Thus, going forward, the government could find increased tax base when the situation normalized. The extra revenues in the long run will cover the fiscal costs of this policy. In case these loans turn bad, government can clean the balance sheet of commercial banks replacing their bad debt with its own debt (a kind of quantitative easing as practiced by US and other economies in the wake of the Great Recession of late 2000s).
These are extraordinary times. The government should step up and take the responsibility and offer coherent plan to deal with it. Otherwise, our future generations will be recalling Keynes’ immortal lament.