The corona-crisis has begun with a different sort of contagion than the 2008 financial crisis, but its impact on financial systems and economic activity is similar
In October 2018, UC Santa Cruz’s Center for Analytical Finance organised a panel discussion on the lessons of the 2008 financial crisis. This was just after the 10th anniversary of the Lehman Brothers bankruptcy, which was the tipping point for the crisis, and the recession that followed. The panellists noted that while much had been done in terms of regulatory systems to defend against the kinds of problems that emerged in 2008, the regulations were imperfect. They also noted that future problems could arise in completely new ways, citing cyber attacks and an unsustainable debt build-up in China as two possible examples.
Financial systems are subject to contagion, and that is what makes financial crises so dangerous to the real economy: As the dominoes fall in sequence, the lubricants, of money and credit, that keep the real economy functioning dry up. Sudden, short-term stoppages of real activity create liquidity problems; demand collapses, resulting in further financial meltdown. The coronavirus crisis has begun with a different sort of contagion, and the sequencing of dominoes is different, but the negative spiral for financial systems and real economic activity is similar.
Countries are responding with different degrees of speed and urgency, but one thing is clear—the United States has, so far, provided one of the worst responses possible, and caused unnecessary human suffering and economic damage. The Trump administration has two characteristics that have been evident throughout its three years of functioning. The first is placing loyalty above expertise, to the point where expertise is almost completely irrelevant, or even seen as a negative. The second is a tendency to lie blatantly, to deny reality, and to viciously attack truth-tellers. These characteristics were evident in the lack of expertise in the White House (the experts were fired a couple of years ago), and the continued denial of the reality of the situation.
The consequences of the Trump administration’s incompetence and dishonesty have been a failure to develop testing capabilities (somewhat analogous to not knowing what the true financial health of the investment banks was in 2008, which was a deliberate choice of the Securities and Exchange Commission under George W Bush), a failure to provide equipment, supplies, and capabilities to support prevention and treatment, and a failure to provide meaningful guidance for individual behaviour. Instead, Trump obsessed about the stock market’s behaviour (a symptom far removed from the causes needing attention), his re-election in November, and the “foreign” origins of the virus. Sections of the media that slavishly support Trump and his legions of cult-like followers spent time attacking the Democratic party, and spinning outlandish conspiracy theories—both hallmarks of the Trump style of operations, before his election, and since.
Interestingly, it was the moves of educational institutions, sports teams, and mass entertainment providers that finally turned the tide. Also crucial have been the responses of governors of US states. Democratic party governors, in particular, have used their executive powers to enforce measures designed to mitigate the virus’s spread, though they have been seriously hampered by the lack of ability to test widely. Meanwhile, the federal government’s response has continued to be slow, incoherent, and sometimes exacerbating the problem, as when Americans were panicked into flying back from Europe without adequate planning to safely receive them at US airports.
What lessons does the US experience have for India? First, political leaders who deny reality, and are more focused on looking good and retaining power than on the welfare of citizens at large, will tend to fail in a crisis, although they may be able to hide their failure from many by manipulating the media. But, the manipulation of the media (with the media’s own complicity) prevents the problem from being recognised and acted on.
Second, leaders who do not trust expertise and surround themselves with flatterers and loyalists, rather than with competent people, will not be well prepared to deal with a fast-moving crisis. Assembling expert teams, and embedding them in the wider system takes time, and time is of the essence in a crisis.
Third, having a well-decentralised system can be helpful. US state governors are speaking to each other, and sharing best practices, especially regionally. In some cases, this has helped cut across partisan mistrust—though it is also the case that some Republican party governors have not completely bought into the Trump cult of denying reality. Governors also know that they are accountable to their own electorates, and will be judged at the next election. India lacks good decentralisation in many of these aspects. Of course, good central decision-making is vital, but decentralisation can compensate for central failures, and even provide role models for how to fix them.
A fourth lesson goes back to the financial crisis of 2008. The US Federal Reserve has responded magnificently to the current dangers to the financial system. And, the financial regulatory reforms of the past decade have insured against the worst vulnerabilities of that earlier period. India has a rolling financial crisis that has not received the urgent attention it required, and which is exposing the enormous failures of its regulatory regime. Two types of contagion at once will be a monumental challenge for the country in the next few months.