Should governments intervene in markets?
This question is at the centre of the oldest debate in economics. One school of thought has argued that free markets work best on their own with little or no government influence. The slogan: markets know better, and governments create distortions.
The other camp disagrees. They argue that markets often fail—think the financial crisis or global warming. Government intervention, they argue, must address market shortcomings.
Economic textbooks assume that markets are populated with perfectly competitive firms and institutionalised by secure property rights and enforcement of reliable contracts. Alas, markets, especially in our climes, are neither perfect nor competitive; neither are property rights and contracts reliably enforced.
Today's events provide more ammunition to the government intervention side of the debate. Even traditional free market champions like hedge funds managers are calling for aggressive government intervention.
How could a free market possibly deal with COVID-19 without a government response?
It's hard to argue that governments should sit back at a time like this. In fact, there are three scenarios, illustrated as swans, that demonstrate the importance of government and roles of institutions.
First is the emergence of Black Swans, Unknowns Unknowns, which are events that emerge unpredictably, that we are neither aware of nor understand. The coronavirus outbreak emerged as a health pandemic that was not predicted to rock global financial markets, which have now declined by nearly a third and suffered extreme volatility.
A popular Wall Street fear gauge index, the VIX, jumped by over 200% in 3 weeks to a new record high of 82, surpassing 2008 financial crisis levels.
Businesses and supply chains are being disrupted, while demand is being depressed at the same time. China's industrial production and fixed asset investment are estimated to have fallen by 14% and 20% respectively.
As the engine of growth for the global economy falters, the impacts will be felt far and wide, especially in Africa and Nigeria. Global commodity prices that low-income economies depend on are collapsing. Oil prices have declined to the mid-20s, a 17-year low, with significant fiscal and budgetary impacts, and causing exchange rate depreciations.
Worryingly, African economies also have less reliable health infrastructure and systems to cope with the pandemic. While the pandemic has overstretched health-care systems in developed countries, many African countries have limited health infrastructure capacity to cope. Nigeria has approximately one hospital bed per thousand people compared to Italy's three beds.
The good news is that intervention is the approach being adopted by all governments globally. The coronavirus black swan event is challenging the free-market orthodoxy. In abnormal times, such as we are now, there have been clarion calls for governments to address the health pandemic, stabilise markets and save the real economy from a deep recession. Central banks have held emergency meetings, slashed interest rates, and pumped liquidity to encourage banks to keep lending to businesses.
On the fiscal front, governments are scrambling to save lives, the financial markets, and the economy. The US has approved around $2.2 trillion or 10% of GDP to bail out industries ranging from leisure, hospitality, health industries, airlines, and sending checks to consumers.
Estimates say that close to $4.5 trillion of liquidity would likely be provided by the US Federal Reserve and the fiscal authorities in the US, combined. Britain is pumping over $300 billion or 15% of GDP in its stimulus package and has promised to cover 80% of workers' wages.
In a crisis where even the epidemiologists can't accurately predict the severity or duration, governments, all over the world, are doing anything but sitting back expecting markets to save the day.
In short, the state is quickly growing bigger, and few people oppose it’s expanding reach.
White and Grey Swans
The second swan to remember is the White Swans—those Known Unknowns, things that we are aware of but do not fully understand. Now that the virus is in full swing, it is now becoming a Known Unknown. But this is only with hindsight. There are risks that economists know can cause a crisis, and we often keep an eye out for them.
In financial markets, white swans are more common as economic vulnerabilities, financial excesses, and policy uncertainty. Here, the role of government is to keep these factors in check with macro-prudential regulations. You don't need an unknown shock or crisis to develop before you regulate non-performing loans, for example.
Perhaps of more importance in normal times are the Grey Swans. These are the Known Knowns—things that we are aware of and understand. A central tenet of economics is that incentives, including market prices, are essential to changing the behaviour of businesses and individual agents.
Market prices drive the amount of alcohol or education we consume, and even how much we pollute.
However, economists often take for granted the legal framework, institutions, and customs that shape markets to begin with. We know that governments and institutions play vital roles due to market failures arising from excess pollution and the underconsumption of education. Without governments, markets will not provide street lights or military defence.
In Africa, countries like Ethiopia, Rwanda, Senegal and Tanzania that have sustained high growth rates of above 6% over the past decade are those with strong governments and effective institutions.
These economies thrived with a healthy dose of government intervention in areas we know are important.
In a situation of crisis, policymakers are at crossroads, though. In essence, there is a need to act swiftly in addressing emerging problems. But governments need to act in a manner that does not lead to long-term moral hazard in the economy. This is when economic agents, especially banks, become reckless, expecting governments to always come to the rescue.
More than ever before, the lessons of this pandemic include building efficient and effective public institutions; developing health and education infrastructure; and effective research to support innovation for sustainable economic development.
In particular, the digital economy—telemedicine, genomics, edTech, fintech, e-cloud, and so on—will end up being the biggest beneficiaries of this pandemic. Still, these technologies require support, such as investment in energy and broadband connectivity infrastructure, for which governments remain important facilitators and regulators.
Dr Temitope Oshikoya has a background in economics, finance, and law. He is also the co-author of Frontier Capital Markets and Investment Banking.