Whatever anyone might believe about the dangers of the Corona Virus, there is no doubt that the American economy, in fact every economy, is heading into recession. There will be a large fall in output and a rise in the rate of unemployment. All this is inevitable. But what must be understood if policy is to achieve a positive outcome is that the downturn cannot be understood as due to a fall in demand as modern economic theory would have it, but will be due to a massive structural shift in our economies. It is not that we will be buying less because we are saving more, but we will be buying not just less, because we will be producing less, but we will not be buying many goods and services we had been buying until concerns about the virus became so general. Lots of forms of production, such as air travel and restaurant meals, will experience a major contraction in demand because of the fears that certain activities are now forbidden or many people have self-isolated.
As every pre-Keynesian economist once knew, recessions do occur but NEVER because a deficiency of demand. When they occur, they are the result of a structural shift in the underlying economy. We are now in the midst of one of the most profound shifts in the international economy ever seen. Just the restaurant trade is facing a major fall in demand, along with airline travel, tourism and lots of other parts of the economy. The structure of the economy is under immense stress. The downturn which is inevitable is due to a structural shift, not a fall in demand. Everyone once understood that. Since 1936, since the publication of Keynes’s General Theory, this then-universal understanding of why recessions occur has disappeared utterly from economic discourse. I used to think the pre-Keynesian conception was obvious, but have discovered to my amazement that virtually no one any longer understands it. We are all Keynesians now, except for a handful of others who have retained this older, now abandoned, approach. But what has amazed me now even more is that the approach taken by Donald Trump in trying to deal with the coming downturn clearly takes a classical approach to softening the economic fall-out that is now inevitable.
Nothing will prevent a downturn now, but what must be done is:
(1) ensure those who are now being temporarily displaced from their paid employment are receiving cash in hand so that they can buy what they need,
(2) businesses, whose revenues will be falling and in many instances be reduced to zero, must have an immediate fall in production costs through perhaps cuts to various forms of taxation, along with receiving cash injections so that businesses which will return to profitability after this disruption are able to maintain at least part of their cash flow and pay their bills, not just so that they can stay in business but that so too can their suppliers
It is the structure of demand that needs to be preserved, not the level. The level of demand will fall, but the crucial issue is that the structure of demand will also be badly affected. The aim of policy must be to ensure that the underlying structure of supply is maintained. This is what is meant by supply-side economics. It is to maintain the structure of the economy that matters. Maintaining the structure is crucial, not the totality. Demand is constituted by supply, and supply will be falling all over the place and therefore so to will demand.
See the airline industry as a clear example. People will one day wish to fly as they have always done, but the airlines must be preserved in the meantime. Virtually every industry is in exactly the same position. No revenue or drastically reduced revenues at the moment to meet their costs, but also with a certain expectation that demand will return in the near future. The aim must now be to preserve as much as possible.
The photo above was taken while watching Fox with the proposed government approach stated as follows:
RPT:PROPOSED GOVT STIMULUS PKG WILL INCLUDE $1200 FOR SINGLE AMERICANS AND $2400 FOR COUPLES
As we think of things today, it has to be presented as a “stimulus” as if the aim is to raise the level of demand. It is, nevertheless, an approach to dealing with a structural shift in the economy, and the aim is to preserve as much of the economy as can be preserved for when things return to normal. The policy proposal is discussed here: GOP coronavirus stimulus bill unveils $1,200 checks for public.
“Recovery checks of up to $1,200 will be put into the hands of most taxpayers, providing cash immediately to individuals and families,” the Senate Finance Committee said in a statement.
President Trump requested that the legislation include the direct payments to boost consumer purchasing. The White House requested two $1,000 waves of checks to all taxpayers.
On the business side, there is also this:
The package also includes $300 billion in small business loans, which would be forgiven if the firms don’t lay off workers.
Another $58 billion in loans would go to airlines suffering a demand plunge worse than after 9/11, with another $150 billion of loans and loan guarantees to other businesses.
This is obviously also intended as a means to maintain the structure of the economy, not as a “stimulus” to lift demand. Among the good luck of the moment is that the President is a former businessman who understands the problems facing business and what needs to be done immediately to minimise the long-term harm to the economy. I can only hope the same approach is taken across the world.
Having just finished the first round of editing of my next book, Classical Economics and the Modern Economy, let me recommend it to one and all once it is finally published in June. It is even possible that classical economic theory may once again come back into fashion. The benefit to our economies and future standard of living would be massive.