All governments today are groping for the optimal balance between economic activity and health risks. One of the side effects of this is to cast a cruel light on the futility of official economics. The theme of arbitration allows us to show its limits, and to point out – hollow – the problems we are and will be facing. We will start with a parody.
The arbitration between GDP and death: a (semi) parody
The analysis of an Orthodox economist could be as follows. First point: there is an inverse relationship between the number of deaths and the loss of GDP. To obtain the minimum number of deaths (Nmin), the economy would have to be drastically curbed by freezing all non-essential activities. But the loss of GDP would then be maximum (Qmax). If economic activity is given priority, the number of deaths will be maximum (Nmax), but the loss of GDP will be reduced to a minimum (Qmin).
The blue segment of the graph below represents the possible combinations between the two objectives of alternately reducing the number of deaths and the loss of GDP. We will assume – for now – that this “budgetary constraint” is linear, and above all given, depending on the characteristics of the epidemic, and the response capacity of the health system.
How then to choose the best combination? Theory provides the answer: there is, at least implicitly, a preference function which expresses the choices of the “representative agent” with regard to the two determinants of its utility function U: income (Q) and health, measured by the number of deaths (D).
This function can be written: U = f (Q, D). Utility increases with income and decreases with the number of deaths. We therefore have: dU / dQ> 0 and dU / dD <0.
The green curve is an indifference curve: it is the geometrical location of the couples (Q, D) providing the same level of utility, or rather of “ophelimity”, to use the term coined by Vilfredo Pareto. The latter proposed using the term “to express the relationship of convenience that makes something satisfy a need or desire, legitimate or not “. The author of a mediocre – but representative – course material used the term “isophelime”, no doubt to bring his little pedantic stone to science.
The graph shows only one “isophelime” curve, which is tangent to “budget constraint”. Located higher, it would correspond to a higher level of utility, but incompatible with the constraint. Lower down, it would obviously be sub-optimal. In short, the optimal combination (Qopt, Nopt) is obtained at point O where the indifference curve is tangent to the line representing the constraint.
“We can’t let the cure be worse than the problem,” Trump wrote in a March 23 tweet. He completed the statement of this principle with clear strategic direction: “At the end of this 15-day period, we will make a decision as to the way forward “. Following his boss, Lawrence (Larry) Kudlow, his chief economic adviser, hit the nail on the head of Fox News. For him, the economic damage caused by social distancing is “just too great”. We cannot stop the economy, and we will have to make difficult trade-offs between protecting Americans from the virus and returning the stock market to its previous level . ”
Note in passing that, for Kudlow, economic activity is measured on the stock market. It is also worth stopping at the character whose portrait allows us to measure the degree of intellectual decay achieved in the United States. The one who acts as Trump’s chief economic adviser could indeed be described as an “Always-Wrong Pseudo-Economist”. In 1994, Kudlow had been dismissed from Bear Stearns Bank for his addiction to cocaine and his alcoholism: this is a good illustration of the distinction drawn by Pareto between ophelimity and usefulness. He will be converted into an economic editorial writer on the CNBC television channel. He accumulated errors throughout his career, denouncing for example in December 2009 (!): “The obstinate refusal of the Obama team to trust the free market. In some of the hardest hit regions of the country, markets are already solving the housing problem. ” On February 25, he again declared that the epidemic was “contained” and that despite the “human tragedy” it represents, it should not lead to an “economic tragedy”.
Arbitration in curves
Our little model presented above may seem a little too caricatured. Yet it represents well the substrate of the dominant economic thought, as confirms Emanuel Ornelas, professor of economics at the Sao Paulo School of Economics: “at the height of a serious epidemic, he writes, an almost complete confinement is better than anything in unprepared countries. However, containment should not be of long duration, its duration being determined by its (health) benefits and marginal (economic) costs. ” And it produces the graph below, which is just another way of representing the trade-off between GDP and death toll. The two curves intersect at a point which determines the optimal duration of confinement.
Three economists, probably more serious than Kudlow, recently published an article modestly entitled “Macroeconomics of epidemics”. They are inspired by an old model, since it dates from 1927. This model is called SIR: S for Susceptible (to be contaminated) I for Infected (contaminated) and R for Recovered (healed). We sometimes add an E for presentations. The central message of the paper is that there is “inevitably a trade-off between the severity of the short-term recession caused by the epidemic and the health consequences of it. Managing this arbitration is a major challenge for political decision-makers ”.
If we want to avoid that “the competitive equilibrium is not socially optimal”, we must balance the efforts and accept a greater reduction in consumption in order to reduce the number of deaths, as illustrated by the graph below . Again, this is just a derivative version of our basic scheme where there is a trade-off between loss of GDP (here consumption) and death toll.
Italian economists have gone to six to find ways to organize the fight against the epidemic, with the same concern of not “killing the world economy.” Since young people are supposed to be less vulnerable to the effects of the virus, the main suggestion is to “put them back to work quickly”, by providing them with an application allowing them to “immediately follow the contagion that they can spread or receive”.
For Richard Balwin, an economist fascinated by globalization – which for him is a kind of second nature of humanity – the most worrying question is that of inflation. According to him, the crisis will cause a relative scarcity of essential goods, and therefore an increase in their prices. His demonstration is based on one of these “crobards”, which are read by economics students from their first year of study. We reproduce it below for its obvious educational interest.
But what worries Baldwin most of all is that citizens may find the increase in the price of essential goods “unfair” and “perhaps even unacceptable”. According to him, history has repeatedly shown that this configuration risks generating “political forces which lead to price controls and rationing (to distribute scarce goods)”. Behind the curves which move on the graph, one discerns the terror of the dominants: and if this crisis started a movement in favor of the planning of the economy?
The arbitration between short term and medium term
The very idea that there is arbitration was challenged in a joint statement by the Managing Director of the IMF and the Director General of WHO: “At first glance, there would be an arbitration to be done: either save lives, either preserve livelihoods. This is a false dilemma: getting the virus under control is, in fact, a prerequisite for conserving resources.
Francisco Saraceno also criticized the “absurd” idea of arbitration: “saving lives is good for the economy.” He takes the example of the strategy originally envisioned by Boris Johnson. If it had been implemented and infected tens of millions of Britons, “the supply of labor would have fallen for months, and there would have been a major disruption in production ”
The idea is basically that arbitration is of a different nature. We can reduce the productive shock by accepting more deaths, but this choice would lead to lasting damage to the state of the economy. In other words, short-term choices condition the medium-long term trajectory. By wanting to avoid a too marked immediate fall, we would have an exit from the crisis “in U”, or even “in L” rather than “in V”.
The different ways out of the crisis, in V, U or L, are well illustrated by the graph below which is based on the experience of the last crisis. The exit in L is illustrated by the case of Greece, and one can also wonder if this trajectory does not foreshadow the one that will be followed, at least in a certain number of countries.
Saraceno thus details the springs of his demonstration: even if we let the epidemic spread to preserve economic activity, certain sectors (travel, tourism, services) would in any case experience significant declines in activity. “Global value chains would be disorganized, and trade would be impacted (…) Consumer confidence and business expectations would remain depressed for months, consumption and investment would stagnate, government intervention would be necessary as much as ‘it is in the context of containment. Finally, the heavy price paid to the pandemic crisis would have an impact on human capital and therefore on productivity and long-term growth ”.
However, it is not even certain that these effects would not be present anyway, even if we accept a strong recession but more concentrated in time. The authors of a recent paper presenting a “theory of Keynesian supply shocks ” maintain that the shocks linked to the COVID-19 epidemic (work stoppages, layoffs, bankruptcies) can lead to a fall in the even greater demand than the shocks themselves. This approach, praised by Paul Krugman, is indeed fascinating by the sophistication of its modeling. It has the advantage of showing how absurd the opposition between “supply shock” and “demand shock” is: the key question is that of the reproduction of capital. It is not a question of determining a “balance” between supply and demand, but of examining the conditions of this reproduction which can only be analyzed in dynamic.
The trade-off between life and public finances
There is a whole literature on the choices made in matters of public health. It mobilizes the concept of “value of life ” in a cost-benefit calculation logic. It is therefore clearly an arbitration, clearly claimed, as explained by two theorists of the thing: “because we are not ready to sacrifice everything to increase our life expectancy, it means that our life has value , and that this one is finished. Since conscious life is the art of decision, and since decision is the art of comparing values, human beings have no choice but to give relative value to everything. There is simply no alternative. The sage who refuses to do so is respectable, but he leaves the decision maker to the abyss of his choices.
One of the signatories to this strong proposal, Christian Gollier, is the director of the Toulouse School of Economics [sic] chaired by Jean Tirole, “Nobel Prize winner” in economics in 2014. In a recent interview, Gollier the demonstration of his insight by writing that “the advantage if we can say of this crisis, is that it is not structural as in 1929 or more recently in 2008 (…) We are in a complete shock exogenous, with a very strong possibility of rebound and not at all in a shock that requires restructuring of the economy (…) As soon as we can get out, we can again consume and revive the economy. ” Arbitration is not, after all, that complicated: “producers have to bring workers back into the business and resume production.” Even if Gollier moderates his remarks in the rest of the interview, his formula, which implies that the workers would not be producers and that it would suffice to “bring them back to the business”, says everything about the quasi-feudal character and inhuman of this economic “science”.
Several public health specialists have just published a short contribution to the debate opened by the epidemic. They proceed according to a table calculation which leads to this essential result: the maximum reduction in consumption aimed at avoiding deaths linked to the coronavirus is 26%. The way in which this enigmatic result is obtained deserves to be examined in more detail.
The model uses the following variables: d is the death rate likely to strike the population at risk, which represents a fraction 1 / n of the total population, and whose number of years remaining to live is on average L years . The value of a year, v, is measured in years of consumption per capita: if, for example, a year of life is worth $ 150,000 and consumption per capita is $ 50,000, then v = 3.
To avoid the risk posed by the epidemic, society would then be ready to give up a fraction of a year of consumption given by this formula: a = d.v.L / n. The authors give a numerical example, with v = 3, L = 10 and n = 6. In this case, the epidemic is therefore likely to hit one sixth of the population whose remaining life expectancy is 10 years. Since one year left to live is worth 3 years of consumption per capita, the above formula is simply written a = 5d. In other words, summarize the authors, “society is ready to give up 5% of consumption for one year for each percentage point of mortality due to covid-19; if this mortality rate (d) is 4%, this would correspond to 20% of consumption ”. CQFD.
Behind this simplistic arithmetic is a more sophisticated model which uses a utilitarian social welfare function. It depends on the reduction in consumption for a given death rate and should help us, think the authors, to think “the trade-off between the consumption of survivors and deaths due to covid-19”. First, the authors examine the case of a “representative agent”, before introducing a distinction between the “old” (exposed) and the young (in principle spared). In the second case, the acceptance of a drop in consumption is less: 26% instead of 35%. But who decides on this “acceptance”? And how to regulate public health measures so as not to exceed the fateful threshold of 26%?
The trade-off between profit and unemployment
What if there was also a trade-off between profit and unemployment? This is what Patrick Artus suggests from a comparison between the United States and the euro zone: “the European model of job adjustment in a recession (slow, amortized as much as possible) is superior to the model American (brutal adjustment of employment) because it avoids worsening the crisis by the decline in household demand, loss of human capital. But the shortcoming of the European model is that the slow and amortized adjustment of employment leads to a decline in the profitability of companies and their capacity to invest . And Artus to drive the point home: to bring unemployment down after the crisis as quickly as possible, it will be necessary to “avoid a few mistakes” and, in particular, “set up wage moderation, to redress the profit margins of businesses” . ” Perhaps he is right: the real trade-offs to be dealt with are still before us. For example: our lives or their profits.
The trade-off between bogus science and social criticism
This peregrination shows that the coronavirus is also an indicator of the terrible shortcomings of the dominant economic theory. The rather microeconomic approach (the one that purports to provide the foundations for a macroeconomic analysis) faces several obstacles that we have encountered. The first is that a logic of balance is absolutely ineffective, in general, but even more so in the current context. All parameters are changing day by day and, faced with the uncertainty generated by the evolution of the epidemic, traditional economic analysis (the one we are teaching today) can bring nothing to the understanding of phenomena.
In our initial parody scheme, the constraint describing the relationship between loss of GDP and number of deaths (the blue segment) is assumed to be known. However, this is clearly not the case: there is a fundamental uncertainty about its form, and this is what makes it possible to understand the hesitations as to the right method to fight the epidemic: what duration of confinement, what modalities exit, etc.? In addition, this fictitious curve is conditioned by the choices made previously (stock of masks, number of beds and carers, etc.) and it is therefore necessary today to manage a situation previously determined by short-term economic calculation.
The assumption that there is a “collective function of social utility” or a “representative agent” exercising informed choices does not stand the test of facts, because capitalism does not work in this way. To return to our parodic scheme, the fundamental question is to know (and it already arises): who determines the shape and position of the green curve?
As for the obscene recourse to an economic calculation based on a statistical evaluation of the “value of life”, it plunges us into the “icy waters of selfish calculation”. Here again, the developer works: capitalism is a society in which the choices that should be collective, the product of democratic deliberation, are abandoned to private decisions established on the basis of a narrow market calculation. (April 2020)