Opinion

The Day After Coronavirus: Economic Medicine Will Have Painful Side Effects

Like others, Israel is planning to spend big to keep the economy afloat during the lockdown. An unpleasant bill for services renders will follow

David Rosenberg
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Tel Aviv beach deserted as coronavirus containment is imposed
Tel Aviv beach deserted as coronavirus containment is imposedCredit: Tomer Appelbaum
David Rosenberg

Thanks to the coronavirus, we’re living in an age of eye-popping numbers that would have been unimaginable just a couple of weeks ago.

If we didn’t need more proof of that, we have the economic rescue program announced by Prime Minister Benjamin Netanyahu Monday night. The numbers he talked about are in a category by themselves, on a scale Israel hasn’t seen in modern times.

The government spent a total of just under 400 billion shekels ($111.5 billion) last year and ran up a deficit (regarded at the time as dangerously high) of 3.7% of GDP.

On Monday, Netanyahu pledged to spend no less than 80 billion shekels to fight off the impact of the coronavirus on economic activity, an amount equal to nearly 6% of gross domestic product. Much of that will be in the form of government-guaranteed loans, but even so it will boost the deficit to 10% of GDP.

By contrast, during Israel’s last two big recessions, the deficit rose to no more than 4.3% and 4.8%.

Israel’s debt-to-GDP ratio was under 60% at the end of last year, a relatively low rate compared to most of the developed world and a figure that the government has been working hard to bring down. Now, it is slated to jump to 75% in one fell swoop.

Israel is part of the new normal. Central banks are being called on to help, but with interest rates so low there’s not much they can do, so the thrust has been on fiscal measures. Governments have been announcing programs in hundreds of billions of dollars (and in America’s case no less than $2 trillion) to keep the coronavirus lockdown from becoming a coronavirus recession, or depression. Moody’s estimates that extra spending will boost the U.S. deficit to 9.4% of GDP; another trillion, which is certainly possible, would bring it to 14%.

These numbers dwarf the outlays that went into fighting off recession during the 2008 financial crisis.  Back then, U.S. President Barack Obama came under withering criticism from Republicans for breaking the bank with an $831 billion stimulus package. This time, even the GOP wasn’t opposed to a massive spending package, they just wanted more of it to go to business than to labor.

Panic and good economics

What’s animating the spending binge is a combination of panic and what I would call pretty good economics.

The panic is pretty obvious. The pandemic erupted in very short order and no one can say when it will run its course or how many people will be sickened or die before it does. Will there be one wave, or two, or three? Is it here to stay?

What we do know for sure is the huge economic cost of a lockdown. In Israel, for instance, the unemployment rate reached more than 24% Wednesday, yet another number that was unimaginable just a few weeks ago. What is a politician to do? “It’s truly a bridge to the other side of an act of God,” economist Paul McCulley told CNBC.com.

 empty streets in Queens on March 21, 2020
Empty streets in Queens, NY on March 21, 2020Credit: JUAN ARREDONDO / NYT

In the defense of the politicians, the economics make sense. The idea is not to let businesses go under during the crisis, leaving people permanently unemployed and businesses bankrupt, thereby undermining the ability of the economy to return to normal once the crisis is over.

However, it’s only pretty good economics because it’s never been tested under the unprecedented conditions of a global pandemic.

One thing for sure is that governments can’t keep spending more and more money if the pandemic doesn’t let up. Their promises are often being framed as  “unlimited” and “open-ended” aid programs, but in the world of economics, there’s so such thing as a free lunch, certainly one where the courses keep on coming with no risk of the diner’s suffering indigestion later.

For what it’s worth, Israel is in a relatively good position to try and spend its way out of a looming recession. Compared to the U.S., Europe and China, we boosted spending only modestly in 2008-09 and have had a pretty good record of keeping budget deficits low and reducing our public debt burden in the years since then. Much of the rest of the developed world is still suffering from debt indigestion. Public debt in rich countries rose from 59% of GDP in 2007 to 91% in 2013, and with the coronavirus it is fated to grow even more.

On the other hand, some are saying that giant debt burdens are the new norm, and they have a case: Even as they were taking on more debt in the past decade, developed-country governments have been able to borrow at near-zero or negative rates.

That would be like a dream come true. These people seem to think that not only governments, but corporations and households can take on more debt without any consequences. The last decade seems show as much, and the coronavirus borrowing-binge may bolster that thinking. There won’t be any need for austerity to prepare financially for the next recession, war or pandemic.

Caution: When anyone proposes an economic policy that entails no pain, alarm bells should be going off. The reality is that all this spending and borrowing by Israel and the others will have to be paid back through painful spending cuts and tax hikes. In short, we may be saving ourselves from the coronavirus frying pan only to jump into the austerity fire.