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Mainstream, VOL LIX No 1, New Delhi, December 19, 2020

COVID-19 Impact Worse than a War or a Global Financial Crisis | Arun Kumar

Saturday 19 December 2020, by Arun Kumar

Excerpt reproduced with permission from: Arun Kumar’s latest book Indian Economy’s Greatest Crisis: Impact of Coronavirus and the Road Ahead (Penguin Random House India) December 2020 Available via Amazon

"The economies of the world have faced crises from time to time and weathered the storms. There are wars in which production gets disturbed and there are recessions when the economies go into reverse gear. The question is: Will the experience of how to deal with these crises help in the present situation?

The countries in lockdown were producing a fraction of what they used to in pre-pandemic times. As a result, income generation fell drastically. However, consumption has to continue. Savings are the difference between income and consumption. So, as incomes fall and consumption falls less, savings decline. Those who lose work and have no income have to dissave—that is, they have to use up their past savings. Investment by businesses almost stops due to decline in demand and the uncertainty prevailing about the future. These are conditions that have not been experienced since the Great Depression. So, will the experience of the recessions and depressions help now?

Actually, the situation is worse than what had happened during the depression of the 1930s or during the world wars.

During wars, production does not fall—it only gets reoriented to the requirements of war. For example, in Germany during the Second World War, a chocolate factory started to produce airplane propellers. In the US, car factories started to produce aircraft. Further, there was no unemployment because people were drafted into the war effort. This is the opposite of what is being faced during the lockdown now. There is massive unemployment since production has stopped, and people have been laid off.

During recessions and depressions, demand is down and unemployment is high, but it is not that supply stops. There is no curb on producing things. Production is down not because people cannot go to work but because their demand for what is being produced declines. In a lockdown, production cannot take place, so both supply and demand collapse.

Simultaneously, workers get laid off and their incomes fall, and most businesses close down and their profits fall and even turn into losses. The result is that a large number of people lose their incomes and, therefore, demand falls drastically. This is a unique situation and past experiences of dealing with crises are no guide to predicting what will happen in future and how one should deal with the present situation.

In brief, during a lockdown, there is voluntary stoppage of production by society and that leads to a shrinkage of the resource base of the economy. Such a situation is unprecedented.

Therefore, there is need for a new macroeconomic understanding of the situation (See Kumar, 2020i). The macro-variables—output, employment, prices, savings, investments and foreign trade—need to be reformulated and studied in the light of the changed situation.

Lockdown and Macro-Variables

Unemployment, Compression of Profits, Wages and Consumption

During lockdown, as production of most goods and services stops, incomes fall drastically. A large number of workers lose employment since businesses are not able to pay salaries, given that a) their revenue falls to near zero b) they have to bear the cost of holding inventories c) they have to maintain basic upkeep of factories and offices and d) they have to pay interest on their borrowed capital. So businesses start incurring losses even if they were profitable earlier.

In brief, both profits and wages fall in the economy during a lockdown.

In India, it is the large unorganized sector that immediately shut down and a majority of its workforce lost work and incomes."

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