The shock that the European economy has to cope with cannot be compared with any other event of the past seventy years. The scale of the collapse is enormous. Only an extremely rapid and equally powerful financial policy response can cushion it.
German and European politicians have now understood how great the health risks are, especially for the risk groups exposed by the corona virus. The economic and economic policy implications of the economic standstill it has triggered, on the other hand, seem to be less clearly seen. It is significant that Angela Merkel, in her address to the German people, in which, in her own words, she tried to explain the crisis, made no mention of either the economic or the European implications.
What is happening now cannot be compared to any shock of the past. It has nothing to do with the economy and recession – the usual categories such as supply and demand shock are also inappropriate. It is a state-imposed standstill of economic life in large parts of the world. With luck it will also be accompanied by the largest support action by states ever seen.
The overall result of these two actions is difficult to predict. There is no doubt, however, that the distortions will be very great if the states do not act quickly, completely unbureaucratically and decisively. In the euro zone it is also urgently necessary to act in a coordinated and uniform manner, not to mention with complete solidarity.
European policy-makers are apparently not yet fully aware of the extent of the economic shock. Towards the end of last week, the French finance minister was still talking about the fact that the French economy would probably shrink by one percent. That is more than naive. The European Commission is talking about raising borrowing limits. That, too, misses the point. It is more accurate to say that at the moment all rules have been suspended outright. Even the silence of the German government does not indicate that it would be able to give a realistic assessment of the economic situation. But it is important for citizens to know what they can expect in the economic field too.
What to expect
It is impossible to estimate the dimensions of a standstill, as it is now being experienced, because at present it is completely open how long the restrictive health policy measures will apply. One can predict, however, that the decline in production in the first few months will be very far-reaching. Large parts of the manufacturing sector are already at a standstill because, in the current climate of uncertainty, there are simply no major purchases being made, such as buying a car. Nor will companies make any new investments for months to come: they will wait until the situation returns to normal. In services other than health care and trade in essential goods, too, a very widespread total loss of gross value-added, in other words of GDP, is to be expected, because activities in these areas are simply prohibited.
Friederike Spiecker and I have tried to calculate an order of magnitude. The result is shocking on the one hand, but not surprising on the other. Assuming that the German economy is largely at a standstill for four months, the following rough calculation can be made on the basis of the use side of GDP: if private consumption falls to around 57 percent of its usual level during the four months (this is estimated using the weighting scheme of the consumer price index) and then picks up again to the pre-crisis level, its decline for the whole of 2020 will be around 14 percent.
If we continue to assume that the government will maintain its consumption expenditure at the 2019 level, this results in a 10 percent decline in consumption in the economy as a whole in 2020. If we assume that gross fixed capital formation for the year as a whole will plummet to 25 percent and that inventory investments will skyrocket to 100 billion euros (this represents an enormous swing after minus 12 billion euros in 2019), the slump in investment compared with the previous year will nevertheless amount to approximately 60 percent. If one assumes that demand from abroad will slump more sharply than imports, net exports could fall from a good 200 billion euros in 2019 to 100 billion euros this year. Taken together, this would result in a decline in gross domestic product of almost 25 percent.
How the public debt develops in this scenario depends essentially on how much loss of income the state compensates for among its citizens and how much of the loss is borne by the corporate sector and private households themselves. Assuming that the state compensates for a large part of the loss of income and helps troubled companies with loans, tax deferrals and the payment of social security contributions, the assumption of additional government debt of 300 billion euros is rather cautious. The decline in the gross domestic product in connection with this deficit would cause the debt ratio to skyrocket from about 60 percent last year to well over 80 percent.
However, these figures are rather irrelevant. After the crisis the debt brake in the German constitution and the regulations of the Stability and Growth Pact in the EMU will have to be completely revised, so that new state austerity policies are not demanded and expected for many years to come.
How to act
Above all, action must be taken quickly. Everything that the state is now providing in terms of aid payments must be implemented extremely quickly and extremely unbureaucratically. The Federal Government should give all companies without exception a guarantee that loans taken out with their main bank to bridge the slump in profits in the next three months will be fully guaranteed by the state. This would eliminate the need for lengthy balance sheet audits and other risk considerations on the part of the banks. All these loans should carry an interest rate of zero. A check on whether the companies will be able to repay will be carried out after the crisis from 2021.
For the workers affected by the decline in production, the state should go far beyond the current short-time work regulations and replace one hundred percent of wages. In addition, as many workers as possible should be encouraged to sign up as paid workers in areas of high demand – such as agriculture and the industrial sectors that are dedicated to daily supply.
The legal conditions for this must be created. The same applies to recipients of Hartz IV (unemployment benefit), where all verification measures should also be stopped immediately and the standard rates increased by a flat rate of two hundred to three hundred euros. A simple rule is that for the next three months everyone should not earn less income than they would have expected without the crisis. There is no justification for certain groups of the population having to suffer financially, while for many others everything continues as before in this respect.
That is precisely why it makes no sense to distribute money to all citizens as a lump sum. Making payments to everyone, including those whose income is secure, is in no way expedient. It is about reducing the insecurity and fear of all those who are directly affected by the crisis in the form of loss of income. This applies to all workers and all self-employed people whose businesses have been negatively affected by government efforts to slow down the spread of the virus.
Many people are wondering where all the money that the states have to use to prevent the worst from happening will come from. In Germany they are talking about 300 to 500 billion euros, in France 300 billion, in Spain 200 billion and so on.
This money, to put it bluntly, will come to a considerable extent from the European Central Bank. The ECB has just announced that it will launch a 750 billion euros purchase programme. This means that the money will be raised on the capital markets by the states in the form of bonds, and the ECB will ensure that interest rates do not rise despite this action by buying significantly more bonds than before.
This is, of course, indirect financing of the states by the ECB – and it would be honest if this were to be made clear in Europe and if the corresponding legal obstacles to direct financing were finally removed on this occasion. As the ECB can increase the amount at any time, it is clear that there is unlimited aid, even if some neo-liberal economists cannot or do not want to understand it.
The ECB should also – and we have emphasised this repeatedly – ensure that the long-term interest rates of the member states do not diverge, i.e. that no “spreads” are formed, which would permanently disadvantage a country like Italy. But the ECB has not yet taken this step. It continues to adhere to quantitative targets for each country, which are related to the size of the country, but not to the degree to which speculative activities of the “financial markets” affect it. It is to be hoped that the central bank’s president Christine Lagarde has now understood that the ECB is indeed responsible for spreads, having denied this two weeks ago.
On the other hand, as Paul Steinhardt of Makroskop rightly pointed out, the ECB should not buy up corporate bonds. This is a one-sided preferential treatment of large companies that cannot be justified.
Europe has already failed
Europe has unfortunately already failed in this crisis. Instead of recognising at an early stage how great the danger is that countries will take diverging actions, the Commission has been very late in coming forward. In particular, a European Commission worth taking seriously would have at the very least publicly condemned the unilateral and completely dysfunctional closure of the borders between France and Germany by the German side. (Der Spiegel is absolutely right).
France currently has far fewer infected people than Germany; the number of infected people is rising more slowly (as of March 21st, according to the statistics of John Hopkins University on the doubling of cases, which are also regularly published online in the Süddeutsche Zeitung); the country has taken much stricter measures against the virus and is less densely populated than Germany.
It is now becoming apparent that especially in Germany, borders are closed as a reflex action as soon as a difficult situation arises. This blind actionism will not be forgotten and is a massive burden on the European future. Nor has the solidarity that should have been taken for granted among partners been shown towards Italy, currently the country most affected worldwide.
Statements such as those made by the Federal Minister of Finance and the President of the Deutsche Bundesbank, that Germany is doing well because it has successfully consolidated in recent years, are completely inappropriate. Germany has only been able to reduce its national debt because it has used its current account surpluses to use the other countries in Europe as debtors. Moreover, in the current situation it is irrelevant whether a country meets the Maastricht criteria or is well above them. In any case, all countries will have to massively increase their debt.
All in all, the corona shock requires unprecedented fiscal cushioning by states around the world. Beyond the immediately unavoidable damage, the economy must be prevented from going into a downward spiral. This is doable, but it requires an immediate departure from many entrenched prejudices about debt and monetary policy.