18
Mar
2020

Asian man turning around business closed sign

Talking straight on COVID-19: the economic effects will be ugly

by Danielle Wood and Brendan Coates


Published in the Australian Financial Review, March 18 2020

In a crisis the public wants straight-talking. The unvarnished truth is that the economic effects of COVID-19 and the associated public health response will be enormous.

Recession is practically inevitable. But the right government response can minimise the damage a sharp contraction this year will have on the Australian economy in the long term.

There will be multiple COVID-19 shocks. The first is the supply shock. Over the next few months many businesses will be hit by a reduction in supply of imports, particularly manufactured goods from China. Supply-side problems will become widespread as workers take time off because they are sick or required to follow ‘social distancing’ rules.

But this will be dwarfed for many businesses by the shock to demand from the public health response. If we want to avoid significant death rates among the most vulnerable, we will need to slow the spread of the virus. Australians should expect that childcare centres, schools and many workplaces will be shut down for a period.

The economic costs will be large. ‘Social consumption’ – going for brunch, attending a football game, getting a haircut – will dry up for several months. Businesses in the accommodation and food services, tourism, arts and recreation, and retail services will take a significant hit to their cash flows. Casual work in these sectors will slow to a trickle.

Initial work from Warwick McKibbin at ANU suggests a global pandemic like the one now unfolding would see Australian GDP fall by between 3 and 5 per cent in 2020. That would plunge Australia into its deepest recession since the early 1980s, if not the 1930s.

An economic hit of this magnitude also presents big risks to financial stability. Firms and households face a liquidity crunch as incomes take a hit. Banks will see an increase in non-performing loans. Australia’s high level of household debt exacerbates these risks.

This suggests two priorities for the fiscal response.

First is ensuring that otherwise sound businesses are able to survive the short-term hit to their cash flows. Support would reduce the threat to financial stability from widespread default as well as to avoid long-term damage to the productive capacity of the economy.

Second is making sure households have enough cash flow to cover their necessities – rent or mortgage, bills etc – during a period when many will take a hit to their incomes.

About 25 per cent of Australian employees do not have access to paid leave entitlements and those that do may not have enough. And more than 10 per cent of workers are self-employed and therefore have no paid sick leave.

Millions of workers could be out of pocket if there is widespread closure of schools and workplaces. Making sure that all workers have a safety net is part public health response (making sure the sick can afford to self-isolate) and part economic (limiting personal hardship and ultimately financial system risk from a household liquidity squeeze).

But those calling for spending to stimulate demand and investment today are still fighting the last economic war. While these were the first line of defence during the confidence crunch of the GFC, they are less important today when spending is constrained by public health restrictions. Such measures will make a lot more sense on the other side of the infection curve when we are trying to get the economy moving again.

So how does the response to date measure up?

The business side of the government’s first package gets points for both its size and its focus on giving business some cash flow breathing space. The $25,000 income tax write-off for businesses with turnover of less than $50 million is effectively a cash bonus for all small and medium businesses with staff.

The wage subsidy for apprentices should provide an incentive for businesses to keep on their younger workers, those that are otherwise most vulnerable to losing their jobs in a downturn.

But much more will be needed for households. The first package focused on demand stimulus through cash payments to people who receive government payments. It’s hard to argue with giving people on Newstart a lifeline (and they certainly will spend it), but the package largely missed the main target: the ‘affected worker problem’.

The only part of the package that supports cash flow for affected workers is the proposal to abolish the waiting period for the taxpayer-funded Sickness Allowance. But many workers would face a long wait for payments: the average wait today is about 35 days and this will only rise as the number of claims grows. And even with this support many will struggle to pay the bills given that payment is the same as the Newstart allowance.

Payments to households via the personal income tax system (with some means test) are the easiest and quickest way to ensure that working households are able to cope with a hit to their incomes. Fast-tracking early access to superannuation or offering HECS style loans to workers would also help.

A straight-talking and straight-thinking government would deliver these as the centrepiece of a second stimulus package as soon as possible.