Of course, this is a crisis. But a crisis is not just a bad time. It’s a time when our previous beliefs are called into doubt – a period when we see, in the words of Richard Bookstaber: “the breakdown of assumptions that govern the normal application of economics.”
For example, the 2008 crisis showed us that stable economic policy was not sufficient to deliver macroeconomic stability; that recessions arise not just from macroeconomic events, but from the failure of individual companies; and that light regulation is not enough to ensure that banks remain functional. Similarly, we speak of the crisis of the 1970s because the combination of rising unemployment and inflation called into question the belief that Keynesian demand management was sufficient to stabilise the economy.
Which poses the question: what assumptions about economics are being broken by this crisis?
One is that stock markets can be stabilised by value investors buying on dips. As I write, the FTSE 100 has dropped 30 per cent from a level that was already cheap by historic standards without attracting value investors.
A big reason for this is that investors' behaviour, especially at extremes, is determined by what we believe about others’ beliefs. Even if you are convinced that shares are cheap you’ll hold off from buying if you think that others will continue to sell – behaviour that can of course be self-fulfilling. We know, thanks to the work of Cornell University’s Robert Frank, that our choices are influenced by others. But they are also influenced by anticipations of others.
In other words, the economy is, as Brian Arthur at the Santa Fe Institute has said, a complex evolving system in which interactions between people cause ever-changing outcomes. This contradicts the presumption of standard economics, that the economy tends to move towards equilibrium.
A second thing we’ve learned from the crisis is that economic policy can do little to prevent stock markets slumping. The Bank of England last week cut rates and (more importantly) took measures to encourage banks to lend to firms suffering a lack of cashflow while Chancellor Insofar Sunak announced a package of measures to support the economy. Sensible as such measures are, they did not stop the FTSE plummeting.
One reason for this is that shares are globalised so the UK market is dragged down when other markets fall. One reason why they fell is that cutting interest rates is not like pulling a lever with predictable effects. Cuts are also a signal. And the market has interpreted the Fed’s rate cuts as a signal that the US economic prospects are truly terrible.
Another reason, though, is that macroeconomic policy cannot raise demand much if we are all stuck at home – although it might well strengthen the post-crisis recovery.
Which raises a third thing we’ve learned. Traditional macroeconomics focuses upon aggregate demand. What we face today, however, is not just lower aggregate demand, but a shift in the pattern of demand. Let’s say you buy a coffee and pastry every morning on your way to work and then go into self-isolation for a fortnight. You won’t buy 10 extra coffees and pastries when you return to work. But you will have an extra £50 to spend on something else. Our problem, though, is that baristas and bar staff laid off during this downturn won’t quickly be able to retrain to meet that demand. This isn’t just because we don’t yet know what form it will take. It’s also because as Nobel Laureates Abhijit Banerjee and Esther Duflo say in their recent book Good Economics for Hard Times, economies are “sticky”. Resources don’t smoothly flow from contracting industries to expanding ones. Barmen won’t quickly become construction workers on the government’s new infrastructure projects.
Insofar as economies have been stable, it is in part simply because we are creatures of habit. But what if these habits are disturbed?
A further thing we’ve learned is that there’s a downside to labour market flexibility. Countless businesses benefit from the flexibility offered by freelancers, temps and gig workers. But it is these who threaten to spread the virus and amplify the recession. Paul Evans, an official at the broadcast union Bectu points out that freelancers needing to self-isolate for a fortnight might well lose not just two weeks’ work but a longer contract. Their loss of income means weaker demand for other people: that’s how economic multipliers work. Worse still, workers ineligible for sick pay might continue to work when they shouldn’t, thereby spreading the virus to others.
Which leads to a challenge to another assumption. For years, many of us have regarded the welfare state as a way of helping others. It’s not. It’s a public good. In the US, the lack of universal free healthcare threatens to spread the virus as uninsured workers don’t seek treatment. Equally, the lack of sick pay there (and inadequate levels and coverage in the UK) will cause some to keep working, also spreading the virus. And low out-of-work benefits mean laid off workers will suffer a big loss of income, which will mean lower demand for others.
In these ways, better social safety nets are not simply a transfer from us to them. They benefit everybody by sustaining both health and demand.
There’s a common theme here. The very fact that self-isolation is so devastating – economically and psychologically – teaches us that, as the philosopher Alasdair MacIntyre has said, we are all dependent upon each other: my health, my prosperity and my beliefs all depend upon your health, prosperity and beliefs and vice versa. We are not Robinson Crusoes making choices in isolation. Insofar as orthodox economics pretends that we are – which it does to a greater degree than you might think – it is plain wrong.
There is, therefore, a lot to learn from this crisis. But will we do so? After the 1970s crisis we did: Keynesianism and post-war social democracy fell into abeyance. But after 2008 to a large extent we did not: it was largely business as usual thereafter. Which reminds us that it is not just objective reality that shapes our thinking, but also political institutions, interests and the beliefs of others too.
