Business in Times of Corona: The Welfare State May Yet Prove Its Worth

The currently much deplored absence of a social security safety net is a feature – and not necessarily a bug – of the essentially wage-driven growth model that underpins the US economy. However, under the present exceptional circumstances the script normally followed to deal with systemic shocks proves of little use.

At its core, the US response to major downturns has traditionally been to support its outsized financial sector and ensure a continued flow of credit that lets the economy adjust to a new reality via layoffs and other corporate cutbacks. This, in turn, allows for a swift rebalancing of wages and prices and for the effective reallocation of resources (capital and labour).

Such a limited intervention, focussed on a single component of the economic equation, was usually all it took for growth to return. A weak state, low regulatory environment, and large financial sector are all defining characteristics of a nimble yet robust economy that navigates the ups and down of the business cycle with relative ease.

This is also the model that has been exported, with varying degrees of success, to the rest of the world via multilaterals such as the International Monetary Fund whose mantra includes privatisation and deregulation. However, the fact that the admirable success of the US model may also be ascribed to the country’s control of the world’s reserve currency is often overlooked.

Envious of the consistently high growth rates obtained by the US, Europe has tried to buy into this model. Rigid labour markets were duly deregulated, corporate taxes slashed, regulatory burdens lightened, and a reserve currency established. Yet, the transformation ran into trouble when the prized welfare state was put to the axe. Erected in the wake of World War II, the mother of all economic shocks, the ‘nanny state’ is an expression of the deep-seated fears haunting a traumatised continent – and of a collective yearning for security through cooperation and solidarity. The more individualistic US growth model remains alien to most Europeans and clashes with their values.

The welfare state is Europe’s answer to economic shocks. Dependent for their growth and prosperity on international trade, the countries of northern and western Europe use social security safety nets to absorb external shocks where trade is usually the first victim. In general, the more open a country is to cross border trade, the larger its welfare state.

Though not an ironclad rule, it serves to illustrate some fundamental differences between growth models. With a trade-to-GDP ratio of barely 27 percent, the US economy is still largely driven by domestic demand. Contrast that to Belgium (161 percent) and The Netherlands (170 percent), countries where the economy is almost exclusively powered by trade with domestic consumption reduced to a mere afterthought.

The difference in economic growth models helps explain the different responses to the corona pandemic. In Europe, measures to underwrite domestic consumption take a backseat to those aimed at preserving the private sector’s ability to survive the crisis by keeping its workforce in place and protecting its balance sheet. Direct wage support is not needed. Thanks to the welfare state, the unemployed already receive monthly cheques from the government.

The personal security derived from that same welfare state allows European households to carry significantly more debt. Notwithstanding their addiction to credit cards, US households are much less indebted than European ones. In fact, the largest debts are sustained by the Dutch and the Danes who just happen to live in two of the world’s most generous welfare states.

Faced with a crisis of almost unimaginable magnitude, the US growth model is showing cracks as markets remain underwhelmed by the decisive action of the Federal Reserve. Whereas a forceful yank at monetary policy levers used to be enough to put a floor under a jittery market, this time it was largely ignored. The $2 trillion aid package enacted by Congress managed to calm markets for a few days only as it remains quite unclear what that injection of cash aims to accomplish: save consumers, businesses, or both. In the Capitol’s corridors some are already suggesting a massive addendum to the package.

The instinctive urge to rescue the financial sector and ensure the availability of credit may be misplaced when one part of the workforce is laid off and the other part is confined at home. Normal recipes are found wanting when almost the entire economy faces a prolonged shutdown. In light of this, the wish expressed last week by President Donald Trump to ‘restart’ the economy and ignore the pandemic is less absurd than it seems at first.

An epidemiological model developed by the Imperial College London showed that, left unchecked, the corona pandemic’s death toll in the US could exceed 2.2 million. This study, probably more than anything else, galvanised governments into action and decide on lockdowns as the only viable policy option.

However, a competing model presented by Oxford University suggests that a long lockdown would not be necessary, and could possibly even worsen the economic fallout of the pandemic, as a large part of the population – up to 40 percent in the UK – may already have been infected by the virus with most people suffering only mild symptoms or none at all. The statisticians at Oxford explore the tip-of-the-iceberg hypothesis that includes the suggestion that herd immunity is close at hand and may kick in soon.

No responsible government, and that includes the Trump Administration, is willing to take the risk. That puts the US in a particularly difficult bind: going back to work may cause up to 70 percent of the population to become infected with one in ten needing intensive care. Not only would this overwhelm the healthcare system, it would also deprive businesses of labour and thus shut down the economy – again. Moreover, domestic consumption is not likely to pick up when ‘shop till you drop’ suddenly becomes a real possibility.

On the other hand, putting the US economy in cryogenic suspension would tear apart both the country’s social fabric and its growth model. A third option – belatedly embracing the welfare state – is mere wishful thinking: it does not fit the American mindset and cannot be made to dovetail with the broader economic system in the short timeframe available.

That leaves the US to grapple with a hybrid response to the pandemic: preserving the financial system whilst shielding some corporates from irreversible damage and slightly easing the pain for households. It is a conundrum not faced by most European countries as their governments have one mission only: to preserve the capacity of the private sector to spring back to life once the spread of the virus has been checked. The tired welfare state, often ridiculed and dismissed as an anachronism, may yet prove its worth.