What the pandemic has taught us about the economy

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A massive comet is heading towards our planet. Huge dust storm disrupts agriculture across the world. The first catastrophic possibility comes from the new black comedy, Do not seek. The second is the starting point of Interstellar, Christopher Nolan’s 2014 science fiction film. An economist has described such events in a most interesting way. “A negative productivity shock hits the global economy, and various adverse consequences ensue, including The idea trap. Behavioral factors exacerbate the course of events, ”Tyler Cowen wrote of Interstellar on the Marginal Revolution blog.

Economists will identify both cinematic events, Do not seek as good as Interstellar, like great exogenous shocks that change everything. These exogenous shocks come from outside the system. The other type of shock that economists like to talk about is endogenous, or internal to the system. Think about the 2008 financial crisis in the North Atlantic.

And the covid? The pandemic is also an exogenous shock for human society. We now know that this had far-reaching consequences. The pandemic provides economic lessons, as well as lessons for economists. Here’s a tour of some of the issues emanating from the covid shock that I think are important. Needless to say, this list is not exhaustive.

Redux on the supply side: the traditional economy has a clear division of labor. Long-term growth is determined by the supply or productive capacity of an economy. The fluctuations around this trend come from the evolution of demand. A fashionable school of macroeconomics even argues that economies always have insufficient demand compared to potentially available supply. The recent disruptions show that supply chain disruptions can exacerbate both the business cycle and inflation. Supply does not matter in the long run. This is important because an even bigger supply shock challenges us: climate change.

Human action matters: It is now widely accepted that the spread of the pandemic depends on how people react to the situation. Are masks worn? Is social distancing practiced? Are people getting stung? In other words, what matters is not only the interplay between aggregates such as the number of susceptible, infected and cured citizens, but also the way in which individuals behave. Macroeconomists adopted such micro-foundations in the quest to overcome a crisis of Keynesian consensus in the 1970s. Whether this was a good or bad turn for macroeconomics is a wider debate. What the covid experience shows is that you need to understand human behavior – both rational and irrational – when complex systems are unstable.

State capacity is important: this is especially the case on the besieged front line. Public health, as opposed to health care, has externalities that make it a public good under state control. Ensuring public health requires not only funding, but also capacity. There is a widespread belief that the Indian state has enough capacity at the top, but is weakening more and more down the line, until it is almost broken to street level. The response to the pandemic shows that the reality is much more nuanced. The Indian state front line – from Asha workers and battered police personnel to city workers and local medics – have done an outstanding job during the most difficult months of the pandemic. It is the first interface that citizens have with the state. It needs to be strengthened.

Scenarios and Forecasts: Most people like a single number as an anchor to prepare for the future. This is why even traditional models with confidence intervals are often reduced to a single forecast. Economic forecasts are often very erroneous, as are epidemiological models. The world is uncertain, in the sense that there are many things that cannot be assigned objective probabilities. Sometimes it’s better to be guided by the data and then adapt to emerging reality as raindrops of evidence fall to the ground. For the unclear possibilities of the decades to come, it is better to construct scenarios, from an approach partly inspired by the work of the English economist GLS Shackle.

It is an unequal world: John Stuart Mill wrote in his classic book on political economy that the laws of production are unalterable, like the laws of physics; but the laws of distribution can be guided by human institutions. Other economists would say the two are linked at the hip – the way things are produced explains how they are distributed. The pandemic era shows that in India at least, the costs of lockdowns as well as the benefits of economic recovery have been unevenly distributed. The usual assumption is that fiscal policy, rather than monetary policy, must address distribution issues, through taxes and spending. However, a new class of models is generalizing. These HANK models – or Heterogenic Agent New Keynesian – re-integrate distribution issues into macroeconomics. More importantly, the underrated Polish economist Michal Kalecki could make a comeback, just as Hyman Minsky did in the aftermath of the 2008 collapse.

I would generally have ended the year with a fun theme, like what Big Bang Theory’s Sheldon Cooper can tell us about the culture of giving this holiday season (bit.ly/3HbrRGk). Hopefully the end of 2022 will see this column revert to a less bleak theme.

Niranjan Rajadhyaksha is a member of the Academic Council of the Meghnad Desai Academy of Economics

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