Economic Policy for the Pandemic II

by
Robert Waldmann
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I am going to attempt a briefer clearer version of this post

I am interested in critiquing (and mostly praising) the CARES Act and discussing what still needs to be done. I think my points (if any) are that an extraordinary unforseen crisis simplifies some issues and relaxes some constraints. I will now go by topic

1. Aid to the unemployed. There are sudddenly many more people without market income. They need help. Here I applaud the decision to give the unemployed an extra $600 a week rather than increase the replacement ratio of unemployment insurance. This was done, because it is simple and it is possible to get the money to households quickly, but I also think it is better targetting.

Consider two workers with different salaries who suddenly lose their jobs. Is it better to give the worker who had a higher salary more when both are unemployed ? Just giving the same amount to all unemployed people implies a more equal distribution of income among the unemployed which implies higher average utility. Normally, this isn’t the only consideration, because an excessively high replacement ratio distorts incentives. In particular 4 Republican Senators were convinced that the CARES act contained a drafting error as it implied some people would have higher income when unemployed than when employed. Normally this is a problem (even though workers who quit don’t get unemployment insurance) because such generous benefits discourage job search and cause workers to turn down job offers. This is not currently a problem. First job search is a possible cause of contagion. Incentives to just sit at home are often optimal right now. Second, there isn’t a long term reallocation of labor problem. Many unemployed workers can and should return to their old jobs when the pandemic ends. This very much simplifies their problem and implies that they don’t need to be given incentives to find entirely new jobs.

This also means that I think the benefit should go to households where no one was employed in 2019. Here again incentive problems are minor. They too should be sitting at home now. They too will not make plans for the future expecting all this to be repeated. This means I am advocating reversing the 1996 Welfare reform (as I always do).

I think in this case the crudest utilitarian calculus is best — to each as he has need — not to each such as he has need and is incentive compatible.

Another issue is whether to bail out firms and, if so, whether to loan at a penalty rate, at a normal rate, or just give them cash. Here the point is that firms face bankruptcy even if they are viable in normal times and therefore solvent and even if their managers didn’t make mistakes. There is no need to punish people for a disaster which no one foresaw. My point (if any) is that there is no need to reward them either.

Normally, I would like to take from wealthy proprietors of small firms. Again this is pure vulgar utilitarian egalitarianism. Normally, this is a bad idea, because one can’t credibly promise to do it just this once. Once off redistribution from rich entrepreneurs can add to utility, but the threat of future redistribution discourages business enterprise. Again, this is not a problem right now. There isn’t a legal or constitutional restriction on imposing tough conditions on a bailout — participation is voluntary. There is a low incentive cost of not rewarding effort and risk taking when there is an unforseen disaster. (the word unforseen is doing all the work there).

So again, I think this is time for simple vulgar egalitarianism. I would take from shareholders, because they are rich. I would take from individual proprietors because they are rich. So I would make the terms of the bailout harsh, because such policy is taking from those who have a lot.

In particular, I think the Treasury should get an equity stake and so a share of the upside risk. I support this here and now, because I support this everywhere and always. The only unusual thing is that, because firms need cash, I now propose buying newly issued shares not buying shares on the market. But here too the right price to pay is the market price, not the market price plus a gift to the rich. That means a low price if a firm desperately needs liquidity now.

So new shares sold at firesale prices. The reasons for the low price, that is harsh bargain, are the usual reasons — paying more than one has to pay distorts incentives, and giving to the rich is inefficient. The first consideration is relatively minor if the policy is a response to a genuine unexpected exogenous event, but it doesn’t switch sign.

So I say it’s time to drive a tough bargain, time to lend freely at a penalty rate or, even better, time for the state to demand an equity stake in firms (and ban share buybacks and limit managment compensation). I think this becase I think it is always time for the state to demand an equity stake in all firms, ban buybacks and limit compensation. But I can also argue that if these provisions are conditions on a voluntary bailout transaction that the usual case against them is very much weaker than usual.