Rebuilding economies post-Covid-19: Dilemmas and trade-offs

By Piyush Gupta, CEO, DBS Bank

There has been a lot of debate on how to engineer a safe exit from lockdown from a healthcare perspective. While this is no doubt something we must all carefully navigate, attention also needs to be paid to how we will negotiate "the day after" from a macro-economic standpoint.

The short-term policy responses to the crisis were swift and inspiring. Central banks leveraged the playbooks created in the global financial crisis of 2008, eased monetary policy rapidly, and unleashed unconventional tools including unprecedented levels of quantitative easing (QE-infinity).

Governments rolled out fiscal support packages in sizes that could barely be imagined in the past, with schemes that put money directly into the pockets of their citizens and others that provided wage support for companies to prevent large-scale layoffs. Liquidity was made available to private-sector companies through orchestrated programmes of debt moratoriums, as well as government-backed new debt.

The thrust of these programmes has been to buy time, to protect livelihoods in the short term with the hope that the coming months would allow a return to normalcy. Unfortunately, normalcy will be hard to find; the likely extended duration of the pandemic will be exacerbated by structural shifts in production systems and consumption patterns. Some key issues will be the following:

The impact of the crisis will be uneven. In the services sector, demand destruction is permanent - an unused hotel room cannot be recovered - while manufacturing companies can often benefit from addressing pent-up demand. Some sectors, such as travel, may take much longer to recover than others. Small and medium-sized enterprises (SMEs) will be harder hit than large companies.
Work patterns are likely to shift. For example, a greater degree of process automation, coupled with a much larger acceptance of work-from-home practices, will significantly reduce the need for office space.
Supply chain adjustment will accelerate as the vulnerabilities exposed by the crisis catalyse greater onshoring and nearshoring.
Consumer preference may also shift, with habits changing and fear driving a greater shift to online consumption.

The significance of these issues is that companies will be faced not with a temporary issue of liquidity, but a structural one of solvency. Sometime in the near future, policymakers will have to wrestle with some critical questions:

How long can and should the extraordinary support measures continue?
Should support be provided to everyone equally, or should structurally unviable companies be allowed to fail?
How does one pick the winners from the losers in a transparent and socially acceptable way? Who gets to decide?
If some companies are to be supported, then what is the best form of financial support?

The problem of moral hazard

The capacity to provide support is, to a large extent, a function of existing fiscal space. Governments constrained by high debt burdens and extant fiscal deficits find it harder to do this. Countries with the exorbitant privilege of a reserve currency - particularly the United States - can perhaps get away with monetising larger amounts of debt. Emerging economies will be constrained by the need to ensure financial system stability and guard against downward pressure on their currencies and reserves.

However, every country will be equally plagued by the problem of moral hazard, a situation in which companies are seen to have a put option on the government - a "heads I win, tails you lose" situation. Civil society will baulk at large-scale bailouts, particularly where corporate greed appears to be rewarded. In addition, keeping companies going on life support - in the interests of employment protection - also creates a significant overhang on the economy and handicaps growth in the long term. Japan was a good example of zombie companies through the 1990s.

Proponents of creative destruction would argue that the best way forward is to let weak companies fail. An extreme exponent of this was US Treasury Secretary Andrew Mellon, who in the Great Depression advised President Herbert Hoover to "liquidate labour, liquidate stocks, liquidate the farmers, liquidate real estate . . . enterprising people will pick up the wrecks from less competent people". Unfortunately, the resultant carnage, loss of employment and economic capacity may not be acceptable to most governments.

This then argues for a middle path - selective support, aimed at keeping the critical parts of the economy functional. A selection rubric could include entities of strategic importance to the country - industries that play to the country's competitive advantage and core competencies, individual companies that could go on to be sector champions or large employment generators, and so on. Such a process would, of course, be highly controversial and politicised, and could certainly not be left in the hands of the private sector or the financial community alone. Nevertheless, the participation of the financial system will be important to ensure an independent assessment of a company's future prospects, something that governments generally do not have a capacity to do at scale.

In pursuing such a path, governments would be well-advised to consider additional support through equity rather than debt financing. This serves two purposes. Firstly, companies that are over-leveraged and over-burdened by debt will find it very hard to find incremental resources to grow, and will therefore be unable to realise the very ambitions that they were being counted on to deliver. Secondly, existing owners and shareholders will be diluted, so they are not perceived to be getting a free meal.

In summary, viable exit paths will inevitably require much greater government intervention as well as government ownership. It is very likely that we are looking at a prolonged period of large government that has to find the optimal balance between looking after the health and well-being of society at large and enabling robust and sustainable post-Covid-19 economic recovery. That said, well-crafted plans could include an option for business owners to earn their way out in the future, so as to retain their incentives to perform.