Joseph S. Vavra: This is not a normal recession. A normal response will not do.

A Q&A on the early policy response to the COVID-19 crisis

May 29, 2020

Sections Economics Public Policy

Collections COVID-19 Crisis

Joseph S. Vavra is professor of economics at Chicago Booth. This transcript is taken from an interview conducted April 2, 2020.

Who should receive a bailout?

When you’re thinking about bailouts and redistributional policies, to the extent possible, we should be targeting our money in two main ways. One is by trying to limit the direct effects of the recession, trying to reduce the cause, to the extent that we can, by spending more money on direct health interventions. And then, the second is trying to provide liquidity for the companies and the households that are least able to bear these consequences. 

Here it’s useful to distinguish large, publicly traded companies from smaller businesses that don’t have the same broad access to capital markets. 

If you’re thinking about large companies, the issue of bailouts, in some sense, is about the distributional effects between the bondholders and the equity holders in these companies. Bailing out large companies is essentially a transfer to their shareholders. Think about an airline or a large hotel chain or cruise ships. These types of companies—and Boeing—have been directly targeted by some of the policies that we’ve seen. But the airlines themselves are not going to go away. These airplanes are large pieces of capital. The major airlines have pretty much all gone through some bankruptcy at some point over the past 20 years. They’ve managed to continue operating throughout this period. Cruise ships are still going to be around. The liquidation value of a cruise ship is quite low. 

The standard bankruptcy system works well for large companies. It might work somewhat less well in a situation where the court system is overloaded because large swaths of the economy are all going bankrupt at once. But broadly speaking, large companies can continue to operate through bankruptcy proceedings, so it’s not that disruptive. 

I don’t want to say that it’s fair that the airlines, and the travel industry, are getting differentially affected by this pandemic. Or entertainment venues, which have been hit hard. There are lots of companies that have been disproportionately affected by the events. This isn’t through any reckless behavior or fault of their own, which might make it seem like these hard-hit industries should get specific, targeted bailouts. 

A lot of the policy discussion has still viewed this situation and the approach to stimulus through the lens of a normal recession. 

But when the economy is shut down and nobody is taking trips anymore, and no one’s going out to the store, there is going to be lost production, there’s going to be lost income, and that’s going to have to hurt somebody. At this point, there’s no way to get rid of the direct consequences of the pandemic—that we’re all sitting at home and not producing stuff. The question is: Who is going to bear the consequences of this decline in output? 

My feeling is that the people who are most well-off and best able to bear the consequences of this recession should take the write-downs. Now, that’s not fair in the sense that rich shareholders didn’t cause the recession. But if somebody is going to suffer negative economic consequences, this route seems better from a welfare perspective in that the CEOs of airlines and the CEO of Boeing, they’re still going to be able to eat. They’re not going to lose their homes. They have a greater ability to weather this shock than frontline workers or people without savings at home. 

And while bankruptcy works reasonably well for large companies, that’s much less true when you’re thinking about smaller businesses without the same access to debt and equity markets, businesses that potentially aren’t able to continue operations through a sustained period of bankruptcy, that maybe don’t have these kinds of fixed assets with substantial value. It’s much less likely that the bankruptcy system is going to be successful in allowing small retail stores and restaurants, for instance, to survive through this period. 

It’s an undesirable outcome if a bunch of small businesses are destroyed that otherwise would have been successful absent this pandemic. The businesses can potentially restart later, or new businesses can replace those destroyed, but there are large fixed costs and disruption that we might want to avoid through some form of direct loans, stimulus, or grants. 

Hopefully, this is a relatively transitory event on the order of months, not years, and what we’d like to avoid through our policies is that this transitory event has permanent consequences on the economy so that we can’t recover when we get rid of the health threat. 

What other permanent effects might come out of this recession that we would like to avoid? 

When a large fraction of the workforce is sitting idle or unemployed and not earning income anymore, it’s going to be harder for those households to make their mortgage payments. It’s going to be harder for those households to pay rent. If we don’t implement policies to limit the negative consequences of that, it wouldn’t be surprising if, months from now, we start seeing a wave of foreclosures and evictions. 

We know the rise in defaults and foreclosures during the Great Recession had large, persistent consequences for the overall economy, and we do not want to layer an additional Great Recession effect on top of the already large economic disruptions that we’re having. 

Those are the types of persistent, permanent effects that policy should be trying to avoid. And it seems feasible to do in a world where this goes on for two months or three months. The longer this health shock lasts, the harder it’s going to be to limit the permanent effects of this—which is, again, why the most important priority should be direct spending on the health threat itself to reduce the actual length of the recession or the underlying shock that caused it. 

Is economic stimulus the right response to the crisis?

Will the COVID-19 crisis exacerbate inequality?

Has the US done enough to help small businesses?

Could the COVID-19 crisis permanently affect the US economy?

Will this pandemic exacerbate inequality?

This is a major concern. The immediate consequences of the public-health threat and the stay-at-home orders make this clear. If you look at the distribution of which jobs already are most affected by this recession, two or three weeks in, it’s disproportionately hitting small retail chains, restaurants, and bars. These are the types of jobs that are difficult to do from home. They also tend to be the lower-skilled, lower-income jobs. You see large spikes in unemployment disproportionately in these jobs. 

These households have lower liquidity and less savings in their bank accounts, and they’re less able to weather negative shocks when they come along. The direct effects of the recession are disproportionately, at least for now, hitting the people who are least able to bear a negative shock. 

What are the political ramifications?

I could certainly see increased demand for broader, more universal health coverage coming out of this period. The spikes in unemployment highlight some of the concerns about a health-insurance system that’s so tightly linked to employment. Again, the people who are losing their jobs, or even if they are unemployed for several months, are mostly lower-skilled workers in the service industries who are less likely to have health insurance in the first place. Another large swath of the workforce is temporarily furloughed, and they may lose their employer health-insurance coverage, if they had it in the first place. All these people are more likely to suffer negative health consequences as a result. 

The political process for getting to more broad-based universal health care is fraught, but I imagine there might be more pressure for moving in that direction. 

What’s missing from the media coverage of policy debates? 

My sense, from talking to other economists through this period, is that there is unusually broad consensus about what the current economic problems are and what the policy goals should be. One thing that’s missing is some notion of priorities and a discussion of what makes this situation a little bit different from previous recessions. 

Direct health spending should really be the highest priority, by a large order of magnitude, and this hasn’t been broadly embraced by the political debate. A lot of the policy discussion has still viewed this situation and the approach to stimulus through the lens of a normal recession. 

Even the framing of these policy interventions as stimulus, I think, is somewhat misguided in terms of our goals. Right now, our goal is not to encourage spending. That’s a standard policy tool for fighting recessions when they come along: in various ways, we want to encourage people to go out and shop and we want to increase aggregate demand. This will provide some jolt to the economy and reduce the depth of the recession. But we do not want people to go out shopping right now. We want people sitting at home for public-health reasons, and we want to engage in policies that allow people to do that. 

Also, the goal right now is not to encourage jobs. When you see discussion about a new round of stimulus—or about how interest rates are low, so it’s a good time to invest in infrastructure, and we should be encouraging jobs there—all of those things are fine once the economy is in a recovery phase and once we want to boost demand and jobs and output. Right now, we want people to sit at home. The more we can do to get people to sit at home and reduce the spread of the virus and reduce the health consequences, that’s what’s best for the economy, and that’s what we want to encourage.

My sense is there are fairly substantial differences in the social-distancing policies across US states, perhaps due to disparities in the extent to which governors have taken this public-health threat seriously. From my casual reading of what epidemiologists are saying, the places that are currently not hard hit are probably just a little bit further behind on the same path, and that if you’re not engaging in active policies now, you’re going to bear larger consequences later. 

More aggressive early intervention is probably going to lead to better effects in the long run. But of course the more aggressive you are in terms of enforcing social distancing and shutting down businesses, the larger the economic disruptions are going to be. If we’re going to have months of people sitting at home without any work, we need to enact policies that help them survive without any jobs and income. 

The stimulus policy that the United States already implemented in the form of rebate checks did not include undocumented workers, who make up a fairly sizeable chunk of the population and the economy. The political and economic reasons may be obvious, but as a public-health matter, we want this group to be able to stay at home and manage the shock. We don’t want people going to work and spreading the virus. 

If we set up the system to manage this economic event in such a way that we exclude some people from the liquidity considerations and discount them when thinking about the economic consequences, however you feel about the political and economic ramifications of that, it will almost certainly have large public-health consequences, including the ultimate spread of the virus—if we can’t come up with some solution.