Economy poised to shut down to save lives

The COVID-19 pandemic has sent New Zealand into a full-scale lockdown. In doing so, the government is working to flatten the curve and ensure that lives are saved. There is no escaping that this decision puts the economy into hibernation for the next month. Most of what will be achieved in the next four weeks will be maintaining an economic heartbeat while stamping out the virus as much as possible. If this plan is successful, New Zealand can emerge from the crisis sooner rather than later and thereby maximise its chances of regaining momentum in the economy.

This article outlines the economic reasoning that supports getting ahead of the pandemic and taking some incredible economic pain to shorten the overall effects of the pandemic. We also explore why this crisis is different from all other economic crises in living memory, and therefore demands a different response.

Lock it down, stamp it out, recover faster

Stopping the spread of COVID-19 in New Zealand is critical from a health standpoint. From an economic standpoint, the sooner we remove the COVID-19 spread, the faster we can start the economic recovery.

A major shutdown of the country and our economy early in the pandemic (in terms of the number of cases present) attempts to halt the wider spread of COVID-19. If less serious restrictions remained, and community transmission took hold, New Zealand would face two broad outcomes.

  • A high death toll
  • A longer period of pandemic conditions, and lower economic activity for longer if restrictions continued to halt the economy

In going early, current economic activity is lost, but we position New Zealand to halt the spread of COVID-19 and then prepare to recover faster.

Businesses, even when supported by the government, can only weather a downturn in activity and retain workers for so long. Once COVID-19 transmission is contained, economic activity can be revived, having had a month significantly below capacity. This outcome would be the best-case scenario.

But if a prolonged shutdown occurs, it becomes that much harder to regain momentum as people have been permanently laid off, consumer spending potential has diminished, and businesses have closed. These compounding economic losses would stymie the ability for the economy to recover quickly, instead potentially seeing activity slump even further, with people’s lack of spending power holding down aggregate demand, driving more firms out of business, and exacerbating the extent of the downturn.

In short, it’s easier to start a warm engine than one that has frozen solid.

Avoiding an L-shaped downturn

Essentially, New Zealand is aiming to keep the lights on in the economy over the next month so in terms of cashflow for both businesses and households.

The lockdown will shut down a significant proportion of the New Zealand economy. There will be an immediate decline in economic activity that cannot be fully recovered in future quarters. Some people will simply not be able to work, and money cannot be earned or spent in the same way as before.

The best possible outcome for New Zealand would be a V-shaped recovery: where there is a sharp and severe decline in economic activity, but a sharp and strong rebound once the pandemic restrictions are eased (see Chart 1).

However, if economic activity is supressed for longer, a U-shaped recovery becomes more likely. The restraint of activity results in a more sustained loss of productive and spending capacity as more firms go out of business and there are more job losses. The economy then becomes more reliant on some external stimulus to regain momentum, such as a pick-up in demand for our exports or significant government stimulus to boost households’ spending ability.

In the worst case, economic activity doesn’t recover to pre-crisis levels within 2-3 years. In this L-shaped recession, there is some potential economic activity that is forever lost, with businesses closing and labour and capital resources sitting idle for an extended period.

New Zealand’s shift to Level 4 restrictions, although cementing a significant loss of economic activity in the near term, also attempts to “go hard and go early” to stave off an L or U-shaped recovery, and instead aims for a V-shaped recovery.

Pandemics have different economic effects, so re-write the rulebook

Previous economic downturns have generally been caused by financial system collapses (for example, the Great Depression and the Global Financial Crisis), oil supply shocks (such as in the 1970s), or natural disasters that have destroyed parts of the capital stock (the Christchurch and Kaikōura earthquakes). The COVID-19 pandemic is completely different from all of these downturns.

All these previous crises could be mitigated by providing additional funds to households to support demand across the economy and put a floor under consumer confidence.

However, a pandemic and lockdown mean that people aren’t working, people aren’t buying, and so there’s significantly less economic demand and output. In essence, there will be nothing but food, housing, and utilities for people to spend on over the next month. So additional stimulus payments to households cannot stop the economic downturn. However, support for employees and households can help maintain people’s financial security, ensuring that they will be able to resume spending relatively quickly in the recovery phase.

Government prepared and ready to act

The New Zealand government is among the most well-prepared in the world for this crisis, with a strong balance sheet giving it the ability to borrow significantly to support the economy. New Zealand’s ratio of net core Crown debt to GDP sits at just under 20%, with gross New Zealand government debt (an easier comparator with overseas measures) sitting at 30% of GDP (see Chart 2).

In comparison, other countries such as the US, the UK, and Australia all have government-debt-to-GDP ratios in excess of 60%. New Zealand’s lower ratio gives more headroom for the government to borrow to fund stimulus packages. The government’s $12.1b package announced last week means that it still has around $18b it can borrow before net core Crown debt to GDP hits 30%. Ratings agencies have noted that New Zealand government debt could comfortably rise to 50% of GDP in times of crisis.

However, the government must use its financial muscles appropriately. For example, calls for a Universal Basic Income to support New Zealand through the current crisis appear misplaced – this policy would see money paid to everyone, even if they are still working or relatively unaffected financially by the crisis. Instead, the government should concentrate its spending and support on those who could lose jobs or businesses, to ensure the country has maintained its productive capacity and can recover after the pandemic has passed.

To this end, the New Zealand government should consider a form of income guarantee, for a six-month period initially, set at 80% of people’s pre-crisis earnings. This measure would ensure that people can continue to pay their bills, so that the economy maintains a base level of activity.

Looking overseas

At this stage, we are hopeful of a relatively rapid recovery for the New Zealand economy. This hope is based on two key factors.

  • The New Zealand government has taken firm action to suppress the pandemic. The government’s strong fiscal position also means that it can provide substantial stimulus to the economy once the recovery phase is ready to begin.
  • New Zealand’s mix of exports and export markets provides opportunities for continued trade, even in a situation where global economic activity remains depressed for an extended period.

In the export space, there are some sectors such as tourism and international education that will take a very long time to recover from the current crisis. But for our agricultural industries, New Zealand’s position as a food exporter means that we are producing goods that will continue to be in demand.

People will still need to eat. Slower global economic growth is likely to mean that commodity prices will be lower than previously. Nevertheless, we would expect to see less downward pressure on food commodity prices than on prices for hard commodities used as inputs for manufacturing of machinery or consumer goods.

Furthermore, although our reliance on China as an export market meant that New Zealand initially felt very exposed to the international effects of COVID-19, China’s success in containing the virus domestically suggests that its economy is likely to perform better than Europe or the US throughout the rest of this year. China’s economic growth will still be slower than would otherwise have been the case, but we are hopeful that New Zealand’s exporters will be able to continue tapping into what demand there is for our products in China.

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