The concern for the health of the population and the control of the effects of the pandemic, as well as for the reconstruction of the economy will remain, for a long time, among the first ranks on the list of priorities of the leaders of almost all the countries of the world. One of the main reasons for this is that, as can already be seen from the statistics that start to flow again, the effects of the pandemic and of the blockages generated by it aggravate pre-existing inequalities and accentuate the deterioration of the social welfare, vital for the future of our communities. We have all noticed during this period of harsh measures an escalation of tensions between people. Due to the economic effects of the crisis, this could continue, increasing social polarization and the erosion of the sense of belonging (to the community), which might fuel social unrest, globally and regionally.
By Leonardo Badea, Deputy Governor National Bank of Romania
The pandemic we are going through now is not exceptional in increasing pre-existing inequalities. A study published recently by Davide Furceri, Prakash Loungani, Jonathan Ostry and Pietro Pizzuto (researchers at the IMF and the University of Palermo) argues that in the past also, on average, such a major epidemic led to a significant and persistent increase in the Gini coefficient of a country. There are several ways to combat this harmful effect, but the most effective remains probably robust and inclusive economic growth, which may not completely neutralize the phenomenon of increasing social polarization but at least has strong positive effects on the standard of living of all social categories. Hence the need to stimulate the recovery of the economy, as soon as possible after the amelioration of the health crisis, and the conclusion that austerity policies (to control the deficit and debt) are not a solution this time.
In the case of an open, emerging economy, of relatively small size like that of Romania, the way to obtain sustainable economic growth involves identifying the optimal set of measures to satisfy an overly complex system of restrictions. Of these measures, perhaps the most important are:
- Finding the budgetary sources for financing the measures to stimulate the economy under the restrictions of a reduced fiscal space, without resorting only to tax increases (that would generate exactly the opposite effect of burdening the population and the business environment. Instead, measures to redistribute wealth that would not affect the middle – and low-income population may be effective.
- Measures to ensure the health and social security of people, in order to increase the general confidence in society’s ability to react and adapt.
- Attracting and making the most out of the financial resources available under the European Union’s assistance packages and the programs addressed to the Member States.
- More than ever, measures to encourage the capacity to build innovative systems.
In this context, reforming the tax system is crucial, to secure domestic resources to combat the effects of the crisis and stimulate long-term economic growth. Priority should be given to rethinking wealth taxes and combating tax evasion and outflows of profits towards lower-tax jurisdictions. As much as it is possible, governments should refrain from increasing taxes on labor and consumption, considering that, in the coming years, we will witness an increasing social pressures for effective measures aiming to redistribute wealth and reduce inequalities.
From a monetary perspective, if the supply of basic goods and services is ensured, then the risks of inflation are likely to be reduced. Although the sanitary prudence and social distancing measures that will be applied in the future imply higher costs and lower business efficiency for a number of companies, it is likely that entrepreneurs (at least initially) will focus on resuming and saving business, while profits will be only secondary as importance. It is therefore expected that, where possible, these costs will be mostly absorbed by reducing the profit margin and only a smaller part will be passed on to the final prices of the goods and services. This behavior would be more encouraged the sooner the confidence will be restored, so that the business environment will be stimulated to think for the medium and long term, in a constructive and development-oriented manner and not anymore in a crisis mood. Of course, there will be exceptions, (narrow) areas of activity where the increase in costs will not be able to be covered in this way, or where competition is reduced, cases in which prices might increase. For all these to happen, it is also important to restore (redesign) supply chains as efficiently and quickly as possible, to maintain a level of cost competitiveness closer to the pre-crisis level.
The negative psychological effects on consumers, which will inevitably result in economic deceleration or recession following the pandemic shock, is likely to increase the population’s propensity to save (accumulation of reserves or “precautionary balances” by households and individuals), which will also act, at least over the foreseeable future, against an inflationary shock. Moreover, governments will have to cover part of the demand deficit that is likely to result from reduced consumption and take initiatives to support employment and protect employees’ incomes.
The economic situation of extreme complexity and difficulty, unprecedented in the modern era, requires unconventional answers from the monetary authorities. Indeed, they can hide risks and vulnerabilities to the future evolution of the economic and financial system, if they are not properly assessed and managed, just as any medicine brings benefits if included in a proper treatment but can also generate great inconvenience if administered in excess or in an inappropriate manner. That is why the key words for the central banks must remain prudence, balance, careful and thorough evaluation, gradual and proportionate action, in the use of any instruments, including unconventional ones.
It is important for all economic participants to be aware that monetary policy instruments, especially unconventional ones, although necessary and effective when used properly, are not a panacea for solving all economic problems. Their application depends on many constraints in the economy depending on size, structure, degree of technological development, complexity, openness, regional integration, external competitiveness, positioning in international trade chains, the size of domestic capital, monetary circulation, the nature and mechanisms of the payment system, the available reserves (of any kind), the social composition, the level of financial education, the degree of intermediation and inclusion, etc. Basically, monetary policy instruments act on an extremely complex environment, that’s why their functioning depends enormously on many variables and characteristics (including of behavioral nature), so their effectiveness varies from one economy to another and through time, their calibration being extremely delicate.
Public policies that can contribute to economic recovery are not limited to the fiscal-budgetary and monetary field. For example, the non-banking financial sector also contributes to the financing of the real economy, through investment and pension funds as well as through insurance companies. The latter may contribute more to the proper management of risks by the business environment in the future (because in the field of insurance it is inappropriate to have new retroactive actions, where events already occurred and risks / losses are certain), through products and insurance mechanisms adapted to the needs of companies in the new economy, respecting the principles of prudence, solvency, liquidity and viability specific to this sector (including according to the European regulatory framework Solvency II).
The contribution and support of the European Community to the revitalization of national economies in the EU is as important as the actions of national governments. The financial support allocated by the EU budget adds to the financial effort of the governments of the Member States and compensates for the large differences between states in terms of the ability to stimulate the economy because of the different fiscal space gaps in the national budgets.
Right now, in the beginning of the economic recovery, the proofs of solidarity at the Union level have a special significance. In the EU, we have a unity in diversity, that’s why in the current situation it is crucial to continue with the efforts to prevent the sharp widening of the economic and prosperity gaps between Member States. The financial envelopes presented so far by the European institutions for supporting the Member States have the necessary scope and addressability. Romania must make a major priority in absorbing and using these funds efficiently, to support and develop the local economy, as all other Member States are expected to do.
The socio-economic consequences of the pandemic are and will probably continue to be distributed differently at regional level in Romania, due to significant heterogeneity of investment volume and labor productivity levels, as well as different models of specialization between regions. This implies a substantial risk of widening regional disparities in Romania, combined with the risk of slowing down the process of economic convergence towards the EU average.
In view of all this, it becomes of utmost importance to collaborate in a broad partnership that includes the fundamental institutions of the state and those representative of the business environment, and that allows the identification of solutions adapted to each sector of the local economy, to overcome approaches that offer general, unilateral solutions, without making the necessary correlation between needs and resources, and which could produce major macroeconomic imbalances in the future. A success in this endeavor will help to regain the confidence of all categories of participants in the economy, which will certainly prove to be at least as important and effective as financial incentives, because it will help to bring back consumption and investment, implicitly stimulating faster and more balanced economic growth than only injections of money could do.