Quoth Kassandra nevermore

This is my 6^th attempt at writing this blog. I am slow and the situation evolves rapidly. So I decided to go right to the main point I wanted to talk about – governments have a huge role to play in how bad the situation is and will get for all of us. In this blog I will explain how I believe a government should react to minimise the short, medium and long term impacts of the virus on us all.

This reason for the title of this blog is that I am, for once, more optimistic in my view than many of my friends. And I will explain why; get yourself an ice kacang and quoth Kassandra nevermore.

A little bit of economics

Let’s think very simply, the price of something, say an apple, is struck when how much a buyer is willing to pay equals how much a seller is willing to receive. This is the equilibrium price, or the deal price if you prefer.

Imagine eating a nice crunchy apple, you enjoy it quite a bit. Now you are given a second, chances are you will enjoy it slightly less. As you keep being given apples, you will enjoy the subsequent ones less and less. The more apples you have eaten, the less you will enjoy the next one. Therefore, your willingness to pay for the next apple falls the more you have already eaten.

This is the demand curve:

On the other hand, if you are selling apples, you will first pluck the easy ones to reach. But as you have to sell more, you may need a ladder, or a hire someone to climb, so your costs go up as you sell more, therefore you will charge more for the next apple the more you have already sold.

This is the supply curve:

Now all I have to do is to put everyone’s demand curves together to get the market demand for apples, and do the same for the market supply of apples, and I have this neat model (1) showing the market for apples.

Makes sense, right? Nice micro model for the apple market. We can even find the equilibrium price and quantity for the apple market (p* and q*)

To understand the Covid19 situation, we need to take 1 more step: to move from the market for apples (micro) to the demand for all goods and services in the economy (macro). Economists use the diagram below:

Looks familiar? It is the same diagram with a slightly different meaning. Now the demand curve represents the demand for all goods and services (from just apples) and the supply curve represnets the supply of all goods and services (even if you are running a t-shirt factory and you need to produce more, you need to hire more people, and probably pay them more to entice them to join you, pushing costs higher, thus prices higher).

Now that you have the basic tools (2), let’s see what is happening.

A crisis, in our little model, can be represented by either one, or both the curves moving. What do you think is happening due to Covid19?

How many of you know people who have lost their jobs? What do you think this impacts?

On one hand, you can argue that since there are fewer people at work, there will be less supply of stuff. Apples will be left on the trees, the cost of each apple goes up, supply falls.

On the other, as people lose their jobs, they buy less, or are willing to pay much less for the apple now that they have other priorities. Hence demand also falls.

It all makes sense. But what is really scary to me is the people are confused and may make uninformed decisions (or they are right and have bad government support)

Let me illustrate what I mean.

In the 1970s the OPEC first flexed its muscles and the price of oil went up. Now, all industries (especially in the 1970s) used oil whether as fuel, or plastic, a by-product of oil. What happened is that, all of a sudden, the price at which companies had to sell at, rose, the supply curve moved (if it costs me more to produce something, of course I will need a higher price).

However, this was totally new to mainstream economists at the time. And while the diagram below shows what happened, economists could only see increases in prices. And in the past, this meant that demand has increased, so they took measures to decrease demand, make it harder for people to borrow to spend (increase interest rates). This caused demand to fall.

Lo and behold, it made things worse and the world economy got into worse trouble, with more people out of jobs, prices increasing making things less affordable… Was not a good time.

Many people think Covid19 will cause worse economic problems. I believe how the governments react will determine if that is the case or not.

Back to our current situation.

To me, the current crisis is mainly a demand side crisis.

People are afraid of losing their jobs, therefore they spend less, and change their spending patterns. In Singapore for example, many people are buying stuff from supermarkets and cooking at home rather than eating at coffeeshops/hawker centres. And it is real, people are losing their jobs.

Here is where I sneak in a second important concept in economics that helps, the multiplier effect.

Basically, when I take $5 and I buy a plate of mixed vegetables rice, the seller receives it, reimburses the costs he/she incurred – for simplicity the cost of the rice and vegetables – and receives the rest as profit. Then he/she can spend that profit elsewhere, as will the vegetable seller.

Now the key is how much of the $5 is spent again?

In normal times, let’s say that 10% is saved. So out of the $5 I spent, 50c is saved, $4.50 spent at the next stage.  Again 10 pct is saved – 45c – and $4.05 is spent.

This goes on. Fans of math will recognise an infinite geometric progression and say that out of this $5, $50 is actually spent in total.

The $5 spent, has created $50 worth of business.

Now what happens if people lose their jobs? Chances are, they will spend less, so instead of feasting of $5 of vegetable rice, maybe I will spend $2.50. Instantly, instead of generating $50, this generates only $25.

Secondly, if we are concerned about the future, we will save more. So instead of 10%, may be everyone saves 25%. So even if I spend $5, next time $3.75 is spent, then $2.81… for a total of $20.

Now if both happen at the same time, I spend $2.5 and everyone saves 25% rather than 10%, the amount is $12.

Let that sink in, if people lose their jobs, are not confident in the future and save more, in my example, the economy instead of getting $50 gets $12. To make things worse, this has a negative impact and the spiral continues down.

But yes, there is a supply side.

Due to travel restrictions, apples will rot on the trees, manufacturing plants will stop production, but to me these are temporary. Once people can go back to work, to jobs they still have, they will want to.

So how can governments help?

I use the term government in the larger sense of the word, not only do I include head of state/ministers, but also central banks who control interest rates or exchange rates.

To me it is very simple:

• Put money in the pockets of everyone so the impact of lower nutrition weakening the body and increasing chances of catching and suffering from the Covid19 is lower (3).
• At the same time promise this transfer will go on for a while so the confidence of people does not fall.

This should ensure that demand does not fall by much.

At the same time, since people are still employed, neither should supply drop by much. Of course in countries with strict lock-downs the supply side effects will be larger (people still cannot physically go to the factory or the fields) but they still would have jobs to go to, so the supply disruption would be shorter in duration.

How about giving benefits to companies instead? Like what Mr Trump wanted to do?

In Sapiens (4), Yuval Noah Harari argues that companies are human constructs, and humanity decided to give them rights similar to humans. I agree, I would say that companies are a nice way to group people and work towards a goal. But what is important is that the aim of the people running the companies are not the same as the people who work in the companies. For example, the GM might decide that profits would increase if he/she closed an old plant in one country and reopened another with less people elsewhere. I am quite sure the workers at the closed plant would not agree. In this situation keeping people in jobs and their confidence up is crucial. It is best to go direct.

In sum, giving funds to companies with no strings attached need not reap the benefits you may be looking for.

The actual mechanics could involve giving money to organisations and mandating this goes to the employees. The organisations basically benefit from a subsidy per worker, lowering their costs and allowing them to remain in business. It can also take the form of a direct transfer to the employees, with employers decreasing their contribution accordingly (or temporarily renegotiating wages).

How about the interest rate side?

If you are thinking of reducing the weight of debt from companies and individuals, sure that would help. But many are locked into fixed interest products, and furthermore, banks, just like other companies, need not pass on the savings.

Again, I am a proponent of direct action. If we want banks to reduce loan-repayments or even defer payments, I think governments can give incentives to banks to defer loans for a few months. In Singapore especially, where banks have recently declared even higher profits than before (5), this should not be a problem. I am sure nobody wants the housing market to collapse with bad loans when a simple loan restructure could save the day.

In sum, yes, the central bank can cut interest rates and this would encourage borrowing, support businesses. But I think that if governments could work with banks to defer loan repayments for a few months it would be a more direct way of ensuring there is no collapse.

In countries like Singapore where rather than interest rate policy, exchange rate policy is used, a slight loosening would help. More explanations are beyond the scope of this blog (6), but the idea is the same, make it easier for people to borrow or buy stuff.

How does this look like?

Basically, paying people part of their wages and ensuring this will continue for a while pushes the demand curve back to some degree. This mitigates the loss of demand, and thus the total output falls by less than it would. Impact of crisis mitigated.

Conclusion

The government has a huge role to play in how we suffer and recover from the economic effects to Covid19. I suggest that governments take direct action to help people, put money in the pockets of people and guarantee that this flow will continue for a certain number of months(7). What this will do is:

1. give confidence to people to keep spending and create multiplier effects in the economy
2. make people save/hoard less, so there will be more to go for everyone
3. relieve employers from some of the wage burdens and therefore allow them to stay in business.

Additional measures that would help

• declare loan repayment holidays for a few months

There will be costs involved, countries will have to dip into reserves, and it will take time for the reserves to recover, but if reserves are not used in times like this, when will they be used.

In addition, global organisations could help, such as the World Bank or IMF to give no or very low interest loans to individual countries to finance these should their reserves prove insufficient. This would be a great way to show that we are all in this together.

I would also end with a plea: live as normal as possible, patronise your favourite stalls, give them the support they deserve!

The above are some of my favourites, and I have visited them recently.

P.S.

I would just like to add that they way Singapore is dealing with this is great; they are already doing much of this, so many countries could learn from this approach. Size or population concentration may impact how to deal with the virus itself, but dealing with the socio-economic impact has nothing to do with size.

1. I use model because this diagram is a representation of reality
2. There is one more concept that would help, but I will leave it for later, so it does not disrupt the story.
3. Sorry to have sneaked that in, but I believe and extra benefit of this scheme, on top of direct economic impact is to slow the progression of Covid19 by strenghening people's immune systems or making people less vulnerable to the virus
4. https://singapore.kinokuniya.com/bw/9780099590088
5. https://asia.nikkei.com/Business/Markets/Nikkei-Markets/DBS-posts-record-profit-offers-relief-amid-coronavirus-outbreak , https://www.straitstimes.com/business/banking/ocbc-q4-profit-jumps-34-to-124b-beating-estimates , https://www.businesstimes.com.sg/companies-markets/uob-q4-profit-up-10-to-s101b
6. Anyone really interested in exchange rate policy can comment and I’ll try to explain.
7. In fact rather than a transfer this can take the form of a loan from the government to be repaid over a few years, which would ensure that the reserves self-heal after a while.