Published: 8 April 2020, 11:00 | By: Sebastian Hollstein
Goods are not being produced, products not bought, services not used - large parts of the global economy are currently at a standstill. What does this massive cutback mean for our economic system? In this interview, economist Prof. Dr. Andreas Freytag assesses the extent of the crisis and explains what mistakes we should avoid and what opportunities we should take advantage of - and why he doesn't think much of corona bonds.
Mr. Freytag, you were abroad during the initial outbreak of the pandemic. Were you able to return to Germany without major complications? How have you experienced your time in quarantine?
I was in South Africa at the University of Stellenbosch for several weeks, to work on two major projects as part of my honorary professorship there. The first week there went quite normally but after 15 March, it became very quiet in the city because the South African government then took very strict measures to contain the pandemic (when only about 60 cases of infection were identified in the country). Despite the access to German news media, I had trouble assessing the situation in Germany. To return, however, was still somewhat uncomplicated at that time. I have been quite relaxed during my two-week quarantine here in Jena: it involved a lot of work at my home desk, including an incredible number of virtual "meetings" on completely new platforms and plenty of time to read and listen to music. After all, it would be rather inappropriate for members of my professional guild to seriously complain about this restriction. Nevertheless, I think it is quite breathtaking to see the ease with which some ministers or town mayors intend to override civil rights.
Large parts of the global economy are currently at a standstill. Despite its uniqueness, can you think of a historical comparison that might help us to classify this situation?
I myself cannot remember a comparable situation in my life. The global financial and economic crisis of 2008 was a demand crisis and thus must be evaluated completely differently from the supply shock that we are currently experiencing. At the moment, people certainly want to consume, but they don't find the supply. Nor are there any political shocks such as an oil crisis or a civil war. This crisis is really new for us.
In my view, the situation is probably best described by the image of a war economy, which puts all non-systemically relevant production on hold; apart from the fact that there are no deaths, injuries or material damages caused by war. Above all, the 100-percent loss of earnings for some services sectors such as tourism is unique on this scale. It will hardly be compensated for in the future market – unlike with goods, whose consumption can certainly be made up for.
What is your opinion of the Federal Government's crisis policy, especially with regard to the economic aid efforts?
I personally feel that the crisis policy is relatively sovereign, even though it is now clear that the government could have been better prepared. After all, the Bundestag had already carried out a risk analysis "Pandemic caused by the Modi-Sars virus" in 2012, under the lead managenent of the Robert Koch Institute.
As far as the politico-economic response is concerned, one may well praise the government for its rapid and comprehensive measures. However, it is now important to get the aid to the companies quickly; this seems to be a problem. This is a pressing issue, especially for small businesses. For many individual entrepreneurs, their existence depends on days rather than weeks.
A recession seems inevitable at this stage. How quickly will we get out of it?
We won't get through this without a recession, that's already obvious. The ifo Institute has been doing precise numerical analysis and according to their experts, the severity of the recession depends very much on the length of the shutdown. The pessimistic scenario depicts a decline of 20 percent in the gross domestic product. Mind you, this does not mean that everyone loses 20 percent. The consequences are distributed asymmetrically among the population. I think, the scenarios calculated by the ifo Institute are comprehensive. If we succeed in rebooting the economy at least partially before summer break, I don't expect that the recession will last for years. On the contrary: We are quite likely to get a high growth rate in the gross domestic product next year, which of course is due to the sharp slump in 2020.
It is difficult to predict how quickly the pre-crisis level can be reached. After all, it also depends on the development of the global economy, especially for an export-dependent country like Germany, and also with regard to the manifold interdependencies in global value chains.
Which questions do we have to address most urgently, in order for the economy to gather speed again? What are the mistakes that must be avoided?
The success of it all will depend on in the manner in which we will terminate the shutdown and on the behaviour of people afterwards. It will be very important to implement the relaxations of the restrictions with consideration of epidemiological expertise, while at the same time avoiding further restrictions. Anyway, I think it would be a serious mistake to relax the shutdown too late - social consequences would be incalculable. It is essential that the decision-makers and advisers in civil servant positions put themselves in the shoes of those whose income and financial existence is now hanging by a thread.
At the same time, the full restoration of all civil rights is just as important as the economic restart: this also applies for the benefit of economic development. All bans on assemblies, all curfews and any telephone tapping, even if voluntary, must be completely withdrawn. This also means, however, that major events - in sports and culture as well as demonstrations - must be possible again soon. I'm sure there will be some way to organise these events in such a way that we can provide for a certain level of protection.
Do you think that, because of the current increase in public debt – which might increase even more due to possible economic stimulus packages – there will be a lack of financial means for important actions in years to come, such as in the infrastructure sector for example?
I don't think so. All citizens, whether they are users of public infrastructure, taxpayers or investors, are very much aware that this is a truly exceptional situation at the global level. It is of course important that our fiscal policy quickly returns to a sustainable practice after the crisis. In any case, the higher level of debt as compared with the pre-crisis level will not cause a serious drag in government activity, given the special nature of the situation. Now, it will take longer to return to pre-crisis debt levels, but it will not have a negative impact on politics in the short term. It is however true that the course of stabilisation that we have pursued in recent years must be resumed. For it was due to the excellent budget situation in the spring of 2020, that the German government was able to respond fiscally to the crisis as resolutely as it has done.
Could we also see an opportunity in these exceptional circumstances? What could be some fundamental politico-economic changes that it would be the right time for, right now or after the pandemic?
I consider it a necessity that the time after the crisis be used to initiate politico-economic reforms that strengthen the organisation of the market economy. This organisation has been considerably weakened in recent years; without the Corona crisis, the negative consequences would probably have been felt soon, anyway. This includes the system of old-age provision, the regulatory regime, the reduction of bureaucracy, or Handicrafts Regulation Act, the tax system, energy and climate policy as well as the international trade regulations. You can read all about this in my WirtschaftsWoche column (German).
In addition, the European Central Bank should reduce the base money quantity as fast as possible after the crisis. This has increased strongly or will even continue to increase as a result of measures under the European Currency Crisis and the Pandemic Emergency Purchase Programme (PEPP). This is necessary because if the public demand for goods and services grows faster than the supply directly after the crisis, due to various company bankruptcies, there is a threat of inflation. And then,we would be right in the middle of the next crisis.
Only by means of market-economy dynamism can the losses of the crisis be quickly made up for and new jobs created for those who are currently losing their jobs or will lose them in the near future. There will be a considerable structural change to cope with which, in practical terms, means a great number of insolvencies, job losses and the need to start new businesses. This will require dynamism. As the other issues of the present time - such as the demographic change and climate change - will not be decelerated by the Corona crisis, we need dynamic economic development and the innovative power of competition to find solutions.
At present, people constantly talk of „market failures“, as urgently needed medical products are traded at horrendous prices. Is that a just accusation?
Not at all. The markets function exactly as one would expect them to: The existing shortages have translated into rising prices, which in turn are driving many producers to shift their production to the goods in demand. The more new producers enter the market, the faster the price falls again. This has nothing to do with market failure. The term market failure is precisely defined. It is not used to describe results we deem uncomfortable. We are rather looking at technical problems that lead to a failure to match supply and demand: externalities, asymmetric information and natural monopolies.
What you are referring to is an unease about the fact that essential goods have suddenly become so much more expensive. I do not like that either. But I do not see any viable alternative. The market is an instrument for allocating goods, services and resources that has proved to be the most effective. It is not moral or immoral per se. There are always companies that use this to their advantage, however, many others do not. In this context, it would be naïve to expect Chinese producers, who can meet an enormously increased demand from all over the world – especially from the West – not to take advantage of the situation.
It would probably be more correct to view the problem as a government failure. The threat of a pandemic was well known, though apparently it was not present in the minds of the protagonists. There is a lesson to be learned from this. Also, it was unwise to concentrate the market for simple medical products such as masks on suppliers from China. We need to learn from this.
Many of these products, such as protective masks and clothing as well as drugs, are manufactured in China. Can you imagine producing more of these goods domestically again and reduce globalization to a certain extent?
That is not easy to answer. The example shows that it makes sense to diversify your sources of supply – this applies to governments as well as to companies. Nevertheless, there is a strong case for buying products where they are produced at the lowest cost. In Germany, this is possible with the above-mentioned goods. If you source them here, the health care system has fewer resources available for other – possibly equally vital – goods and services.
It is also not easy to increase stock sourcing considerably, in order to be prepared for future crises. It ties up considerable resources that might otherwise have been better used. What's more, many technologies become out-dated quite rapidly, so that large stocks could quickly become worthless. Another characteristic of crises is that they are unexpected and leave people, or politicians, unprepared. There is therefore no guarantee that by systematic stockpiling of certain products we will be prepared for the "right“ crisis.
After all, it will be a matter of achieving a smart mix of national stockpiling, international agreements at the level of the World Health Organization and diversified purchase contracts for vital goods that are as long-term as possible.
However, I do not think it is right to use artificial measures, such as trade barriers, to restrict supply chains to Europe or even Germany as a reaction to the crisis. It is quite possible that value chains will become shorter again as a result of the advancing digitalization. As long as the process happens without political intervention, this does not pose a problem. What is most important is competition and diversification. If there is sufficient competition in the (world) markets, there is no reason why we should not continue to focus on global value chains.
The concept of system relevance is currently experiencing a boom, with occupational groups such as the medical and care sector or in retail trade coming to the fore. Will this appraisal also be expressed financially in the long term, without having to draw on public money? Will the idea of efficiency in the health care system (in terms of economic feasibility) be pushed back?
I assume that there could be increasing pressure to improve the payment of care workers and other, currently heavily strained, occupational groups and to improve their working conditions. For starters, that is positive.
Many caregivers are employed in public institutions and it is entirely up to the political protagonists to start a process here. The Free State of Thuringia, for example, could lead the way by adjusting salary structures and working conditions in the health care system.
But this is - as far as I understand it - a very complex process that will clearly impact accounting systems, health and care insurance contributions and the operating procedures in the health system. It is nevertheless a question of prioritization. By the way, if the public sector leads the way, the private sector will have to follow because public employers would then exert a pull on workers from private institutions.
But as far as efficiency is concerned, it would be negligent to be inefficient because that would mean waste. In other words, too few people would be treated with the resources available or to treat a given number of people would cost more than is necessary. In this context, two things are quite often confused: namely efficiency and the intention to make a profit.
The intention to make a profit must be seen in an ambivalent light. On the one hand, it ensures that the offer is worth its price. On the other hand, if private capital owners demand a certain return on investment from hospital staff, it can lead to savings in staff or elsewhere in the healthcare institution and as a result the quality of treatment would decline. So higher wages for nursing staff could lead to further deterioration in working conditions or savings in staff. This is a question of political regulation of the sector. But it must be considered separately from efficiency.
Europe did not exactly come closer together during the pandemic. Once again, decisions were taken primarily in each nation state. Moreover, when it comes to coping with the ensuing economic crisis, serious conflicts are already emerging on the horizon most notably the debate surrounding the Corona bonds. How can the European Union once again act as a single entity, in order to master the consequences of the crisis?
I don't share your pessimism here. It must be noted that the Corona crisis is happening everywhere at the same time. First of all, every government must look after its own country. And it is highly questionable if all decisions should be bundled in Brussels. One counter argument is the principle of subsidiarity, which states that decisions should be made at the level of those affected, meaning as close to the people as possible. To give a local example: our local shutdown regulations are easier to bear in a city where the university is the biggest employer than elsewhere. Here, a great number of people work from home regularly. In industrial cities the shutdown is far more unpleasant. In addition, the politico-economic responses in Germany are geared to our institutional surroundings. In France, they would probably be less effective and vice versa. After all, while small and medium-sized enterprises form the backbone of the economy here, in France it is mainly the large companies.
Whenever European politics make sense, however, the European Commission does come into action appropriately. I am thinking specifically of the European short-time working allowance.
As far as solidarity is concerned, it is often heavily exploited, especially when governments are under pressure. Corona bonds are not being demanded from Rome and Paris because they are really necessary. Looking at an European Stability Mechanism basket that contains a callable sum of EUR 410 billion and the ECB's Pandemic Emergency Purchase Program (PEPP), which is worth another EUR 750 billion, there is no need for further funds for the time being. Rather, Rome and Paris are probably intending to keep the right-wing opposition in check. Interestingly enough, this also applies to us in the sense that in order not to give the populists a new issue, we must prevent the Corona bonds.
Nevertheless, even from the economic perspective, a European debt mutualisation makes little sense. It distorts the incentives for politicians from all European countries and encourages them to allow for additional expenditures. This is not about a dispute between the "frugal North" and the "wasteful South" of Europe as both concepts are just chimeras. Debt is more attractive to any government, if taxpayers of other countries have to pay for it.
That is why it is now important for governments, together with the European Commission, to make use of the opportunities available and to let this be seen as a demonstration of European solidarity. Mutual recriminations and wordy moralising will not help us.
In your scientific work, you are also concerned with the topic of the economy on the African continent. What do you think the pandemic and the associated economic crisis mean for the countries there?
There are several problems and a glimmer of hope. The glimmer of hope is that Africa as a whole has been less affected by the pandemic than other continents. On the one hand, this might have to do with the experience of the Ebola pandemic and the measures and policies adopted as a result. Secondly, another reason might be the quite successful fight against poverty in the recent past.
However, it is concerning that, in the densely populated townships in Africa's large cities, it is nearly impossible for people to distance or isolate themselves from each other. Furthermore, the health systems are not very efficient and, the social security systems are also rather weak such that it wouldn't be possible to enforce long curfews at all because people would have to go back to work. Finally, this circumstance is worsened by the fact that the current shutdown in the industrialised countries is causing markets for African products to collapse.
The post-crisis phase could also become critical. After the global financial and economic crisis, many G20 countries have sought refuge in trade barriers: It is easy to observe a trend towards highly distorting non-tariff barriers. Products from developing countries, especially food and textiles, are regularly affected most strongly. This in turn affects the poorest among us, because they have to spend a relatively high proportion of their income for these goods. But above all, it affects African producers who can sell less to the G20 countries. This would have far-reaching consequences for us, too: general poverty would rise again as would conflicts and migratory movements.
As devastating as the virus and its consequences are, such an exceptional situation raises many research questions. As a scientist, what is your view on the crisis? Are there already questions emerging that you intend to investigate more deeply?
In terms of national economic policy, it will be interesting to watch how the government protects companies from bankruptcy by taking a stake in them. We will certainly see some partial nationalizations. After the crisis, the state should quickly cut these stakes but is not at all easy: the German government acquired a stake in Commerzbank a good ten years ago and has not yet been able to sell its share package.
An even more exciting question that is downright essential to us in Europe concerns the future order of international relations. Already before the crisis, China had established itself as an important player by making other countries dependent on China. Just think of the "New Silk Road". At the same time, the United States are increasingly withdrawing from their role as warrantor of a liberal world order. How will the crisis change this dynamic? Can it be stopped at all? What roles will the European Union, the G7 and the G20 play in the future?
This, in turn, is also of great politico-economic importance and will certainly have consequences for international trade and the World Trade Organization. I am part of an international research network that is concerned with the increasing erosion of the world trade order ever since the global financial and economic crisis. In politics, it is always easier to erect trade barriers than to remove them again later. Once the shutdown is over, we will have to make swift progress in getting our international division of labour (meaning globalization) back on track. Otherwise, millions of jobs on all continents will be lost permanently.