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The West’s COVID-19 Learning Curve

If central bankers and governments can keep financial markets working and prevent mass bankruptcies during the COVID-19 pandemic, then the now unavoidable global recession could be followed by a vigorous recovery once the virus has been contained. But protecting public health requires Western societies to learn and adapt quickly.

BERKELEY – Politicians sometimes belittle military leaders with the charge that they always fight the last war. But that potted wisdom applies equally to policymakers – and it’s not always a bad thing.

For example, because the memory of the 2008 global financial crisis (GFC) remains fresh, governments and central banks have a keen sense that financial markets might collapse at any time. Faced with the COVID-19 pandemic, they are using every lever at their disposal to avoid a repeat of the financial-market freeze that proved so damaging a decade ago.

The policy reaction to the GFC was somewhat delayed and initially confused, especially in Europe, because policymakers and the public had not experienced a financial crisis or government defaults. But governments and central banks in Europe and the United States learned their lessons, and are now applying them on a vast scale in an effort to mitigate the pandemic’s economic impact.

Therein lies a second lesson from military history: Armies that have actual combat experience tend to be much stronger. And it is lack of experience that largely explains the delayed public-health response to COVID-19 on both sides of the Atlantic.

Neither Europe nor the US have experienced a public-health crisis of this magnitude since the 1918-19 Spanish Flu pandemic. By contrast, Asian countries that had to deal with the severe acute respiratory syndrome (SARS) epidemic less than 20 years ago reacted much faster to the COVID-19 outbreak, implementing drastic containment measures that enabled them to flatten the contagion curve relatively quickly.

The emerging narrative based on China’s experience – that dictatorships are better at fighting an epidemic – is thus wrong. What made the difference this time was that China and other Asian societies had experienced a similar problem to COVID-19 within living memory.

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Democracies such as South Korea and Japan can fight a virus as efficiently as a dictatorship. Indeed, open societies have a distinct advantage over authoritarian states, because unpleasant information cannot be denied or suppressed for long, as it initially was in China. But for Europe and the US, the COVID-19 pandemic constitutes a surprise attack by a hitherto unknown enemy. So, it is no wonder that governments’ initial public-health response has been belated and disorganized.

This botched response is also why financial markets are now reacting so violently. Initially, investors had expected a sharp but short recession, followed by a V-shaped recovery. But as European and US public authorities dithered, the virus took hold – and markets started to panic.

Without intervention, COVID-19 cases seem to multiply by a factor of 4-5 in one week and 20 in two weeks, and potentially can increase by a factor of more than a hundred in a single month. The price of a few weeks of ignorance and denial can thus be huge.

Moreover, the current crisis has not been caused by a build-up of internal imbalances, such as excessive lending to US homeowners or to weak peripheral states in Europe. Rather, it is the prospect of a prolonged period of enforced inactivity – and of waves of bankruptcies, from airlines to restaurants – that is driving valuations down. 

Given the uncertainty about how the health crisis will evolve, investors are trying to sell all risky assets and hunker down. This “mad dash for cash” leads to a chain of fire sales that disrupt normal commercial relationships and threaten the very functioning of markets.

Fortunately, central bankers, with the GFC firmly in mind, are trying to prevent this kind of doom loop. The US Federal Reserve and the European Central Bank have initiated enormous programs to buy everything that scared investors want to dump right now.

The hoarding of cash in a crisis has been compared to the panic buying of toilet paper currently in evidence almost everywhere. But whereas the supply of toilet paper is limited, and increasing production takes time, central banks can create unlimited amounts of money instantaneously. There is thus little doubt that monetary policymakers ultimately can calm markets.

But restoring calm will not be enough, because only larger companies depend on capital markets for financing. By contrast, small and medium-size enterprises, which even in the US employ over four-fifths of the total workforce, rely on bank financing and the continuous cash flow from sales. This crucial sector is thus not much affected by financial-market gyrations.

So, while central banks can ensure that the financial plumbing continues to function during the COVID-19 pandemic, they cannot do much to help millions of small businesses survive a lengthy period without sales. Governments must step in with generous loan and other support programs to prevent mass bankruptcies. And with the experience of 2008-09 still fresh in their memory, they are doing so on a grand scale, albeit in very different ways from one country to another.

The global economy eventually will restart, because all its capital, technology, and labor remain in place. Moreover, past experience suggests that consumers will largely resume their previous spending patterns, as happened even after the Spanish Flu. Although that virus returned more than once, mainly because of the patchy nature of public-health systems at the end of World War I, the globalrecession lasted less than a year.

If the combined efforts of central bankers and governments can keep financial markets working and prevent mass bankruptcies, then there is a good chance that the now unavoidable global recession will be followed by a vigorous recovery once the virus has been contained. But this requires Western societies to adapt and learn quickly how to protect public health.

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