The current economic developments in the Corona pandemic are repeatedly compared with the banking crisis a good ten years ago. How useful such comparisons are and whether there are parallels to the financial crisis of 2007-2009 will be discussed with Prof. Dr. rer. pol. Kay Hempel from the Department of Business Administration, Finance and Financial Services at BTU.
Prof. Hempel, how useful is the comparison with the banking crisis?
The crisis from 2007 to 2009 had its origins in certain events in the financial sector; the insolvency of Lehman Brothers was then the key event of the financial market crisis. Economic stimulus packages and rescue packages became necessary because the crisis in the second half of 2008 had a strong spillover into the real economy. Apart from the problems associated with the bank bailout, it was a typical Keynesian situation that required above all a short-term stabilisation of macroeconomic demand. We certainly all remember the car scrappage scheme, which was a complete success from the point of view of economic policy because the financial resources used had an immediate effect on demand.
The current situation must be assessed differently. Production is down and supply chains are partially interrupted. On the one hand, restaurants and many retail businesses are closed, so that customers can, with the best will in the world, in principle not spend any money here; on the other hand, there is a lack of income, for example, for many self-employed persons, as they cannot pursue their professional activities. It is of course right to help in this situation with subsidies and other liquidity support, tax deferrals and guarantees. The speed with which the Federal Government has been implementing these measures in recent weeks is impressive. This time, however, the crisis originated in the real economy and we must now take care that it does not spill over to the financial sector. This could happen, on the one hand, if a large number of actually healthy companies become subject to insolvency proceedings as a result of the pandemic and, as a result, there is an increase in loan defaults. On the other hand, risks to financial market stability could also become virulent through higher risk premiums on bond issues. Particular attention must therefore be paid to events on the bond markets.
Where do the Federal Government's support measures for companies and the self-employed begin?
The basic problem of many companies affected by the "shutdown" is now that fixed costs continue to be incurred even with a zero output volume. Although the swiftly implemented relief from short-time working allowances may be able to reduce personnel costs, depreciation, interest, overhead costs and other fixed costs continue to be incurred, while earnings fall away completely if no output is produced. The focus of all measures is primarily on securing liquidity, since illiquidity is a fact of insolvency. Against this background, the Federal Government has decided, among other things, to provide immediate aid in the form of grants for self-employed persons and companies with up to 5 employees amounting to € 9,000 (€ 15,000 for up to 10 employees). In addition, a billion-euro aid programme is being set up via the Kreditanstalt für Wiederaufbau (KfW), which aims to provide liquidity to companies and the self-employed. Access to basic security has also been facilitated.
What support measures are provided for larger companies?
In its measures for large companies, the Federal Government can and does draw on the experience gained during the financial market crisis with the then Financial Market Stabilisation Act of October 2008. Two particularly important instruments at that time were the provision of guarantees in return for the payment of small risk premiums and the recapitalisation of companies. The assumption of guarantees was extraordinarily successful at that time and has brought the fund (SoFFin) not inconsiderable returns through the risk premiums. The new Economic Stabilisation Fund will enable capital measures, guarantees and participation in the refinancing of KfW programmes. By capital measures we mean state equity investments in companies, which were also made possible by analogy during the financial market crisis. This can be in the form of shares, but silent participations are also possible. In the case of a state participation in the form of shares, capital increases against contributions by the enterprises are required; additional shares are issued at an issue price to be determined, which results in the desired liquidity and financing effect. From a regulatory point of view, such state participation should only be temporary and only in the case of fundamentally sound companies. Unfortunately, temporary solutions are sometimes persevering; the federal government still holds shares in a major bank from the package of measures taken at the time.
How long can the current situation be economically sustained?
Nobody can judge that exactly and it is not written in any textbook. It also depends on which areas of life are affected by the "shutdown" and to what extent. You can certainly do without hairdressing, concerts and restaurants for a while, but industrial manufacturing, which is part of complex value chains, can be a bottleneck for important products. In the theory of business planning one speaks of the dominance of the minimum sector. Transferred to the current situation, one could formulate that the weakest part of an industrial value chain dominates the overall system in the production of the marketable end product. It is very important that the logistics sector remains stable.
What is the overall impact of the corona pandemic on the economy?
The economic effects of the pandemic are described in detail in the current special report of the German Council of Economic Experts on the assessment of the overall economic development. The Council distinguishes between three scenarios, each of which envisages a decline in gross domestic product of 2.8 % to 5.4 % in 2020. The individual scenarios for the economic consequences are described by a V development, a pronounced V development and a long U development. Whether one of these scenarios will occur is currently completely uncertain. Of course, things could get worse.
In the context of the financial market crisis a good ten years ago, there was even a decline in gross domestic product of around 5.7 % in this country. However, the economy recovered quite quickly because the measures taken by the then Federal Government were very successful. There was a V-development, so to speak.
If the economic situation now recovers quickly in the best case, catch-up effects are undoubtedly possible. In the special report, the Council assumes in this case a possible growth rate in 2021 of about 3.7%. On the demand side, too, the purchases of durable consumer goods (washing machines, freezers, etc.) that are now lacking will mostly be made up for later if household income does not collapse in the meantime. Those who need a hearing aid now and are deterred by limited service will buy it in a few weeks. However, catch-up effects are unlikely to occur when visiting restaurants or the theatre. We should be particularly concerned about the cultural sector.
What medium-term effects do you fear?
In the short term, I think that the current measures are appropriate to the situation. We are now benefiting from the fact that the state has, on the whole, been running a very solid business in recent years. For some years now, a substantial general government surplus has been achieved, combining federal, state, local and social security funds. Although I would have liked to have seen a shift in emphasis in recent years from consumption-oriented to investment-oriented government spending, this cannot be changed now.
Even if everything was done right in the short term with the expansionary fiscal measure, this may look quite different in the medium term. At present, we should view economic development primarily as a "supply shock," which, due to the loss of revenues, is naturally associated with far-reaching effects on overall economic demand. If there were to be a relatively rapid economic recovery in this country, a combination of expansionary fiscal policy and expansive monetary policy after 2020 would be critical, as it will sooner or later result in a noticeable rise in the consumer price level. The "shutdown" represents a restriction on the supply side of the economy and I fear that the effect of demand-side economic policy will be overestimated by the players involved in a few months' time. Professor Berthold of the University of Würzburg has drawn a parallel in recent days in a regulatory journal to the stagflation at the end of the 1970s. That corresponds exactly to my opinion. In simple terms: If structural policy challenges or restrictions on the supply side are met primarily with expansive economic policy measures, stagflation - i.e. a combination of stagnation and inflation - can occur. A comparison with 1979/80 is obvious in this context.
What role do international supply chains play? Do adjustments need to be made here?
We are all learning from this exceptional situation. Many companies will certainly have to think about making adjustments to the pronounced internationalisation of industrial value chains over the last two decades, not least from the point of view of a functioning risk management system. In critical areas - such as healthcare - the state will certainly be in great demand here as a regulator. In other purely market-based sectors, however, it is to be expected that decisions on the vertical range of manufacture of industrial companies will continue to be made primarily on the basis of cost efficiency. Only in this way will industrial companies remain competitive in international markets, especially if their products are not particularly differentiated in sales markets. However, the more intensive international division of labour made possible by globalisation has undoubtedly brought major welfare gains for us all.
Can foreign trade effects be assessed in any way?
Since the whole of Europe is affected by the pandemic with varying degrees of intensity, the coordination of economic policy measures at European level is of course also of paramount importance. But this is done anyway. For severely affected countries with less fiscal room for manoeuvre, the European Stability Mechanism (ESM) rescue fund is available as an instrument at European level. I hope that it will be used accordingly. Foreign trade effects will also influence economic development in this country. Even if economic development in this country returns to normal to a large extent during the summer half of the year, the delayed pandemic-related measures in other countries or economic difficulties in other countries may continue to have a braking effect on German export activities. In this respect, the country's own economic policy measures to increase output are likely to remain largely ineffective.
A lack of economic activity in an industrialized country does not remain without effects on less developed countries. I am very surprised that the macroeconomic North-South relationship has hardly been addressed in the current debate so far. Economic effects are transferred internationally to other countries through various channels. For example, a recession in industrialised countries typically also leads to a decline in imports from less developed countries, which thereby lose urgently needed foreign exchange earnings. Experience, for example, from the recession following the second oil price shock in 1980, also indicates that in such phases primary goods prices often fall significantly. In the worst case, the economic spillover effects of the crisis on less developed countries could lead to a "crisis after the crisis".