With the global fallout from Russia's war against Ukraine coming on the heels of the pandemic, many governments have increasingly adopted short-term emergency measures that come at the expense of future prosperity. To avoid an eventual reckoning, they should emulate a country that actually is at war: Ukraine.
In extraordinary times such as wars, pandemics, and natural disasters, all politicians introduce extraordinary measures to soften the negative economic and social impact on their country's citizens. But only the best among them will do so with the future in mind, helping to create the conditions for longer-term prosperity. As the late Queen Elizabeth II put it, "What leaders do for their people today is government and politics. But what they do for the people of tomorrow - that is statesmanship."
Owing to the fallout from Russia's invasion of Ukraine, many governments today are acting as if they are also at war. But they have failed to heed the queen's implicit advice because short-termism has become all too common in economic decision-making. The current moment stands in stark contrast to the beginning of 2021, when most governments were focused on building resilience, preparing for another pandemic, and gently winding down the financial support that they had provided during the COVID-19 crisis. Preventing excessive strains on government budgets had become a priority alongside longer-term challenges like the fight against climate change. But that now seems like eons ago. True, we have not lost sight of climate change, and Europe's energy crisis will most likely accelerate the green transition on the continent, as more investment is funneled to renewables and permits to build greener energy infrastructure become easier to obtain. But shortages of natural gas have also forced some countries to turn to coal, delaying their plans to phase out the most carbon-intensive fossil fuel.
Now that coal is cheaper than natural gas, kicking the coal habit has become much more difficult. But if the right policies are put in place, faster progress in the future could offset this setback. Besides, no one can blame governments for doing what they need to do to protect energy-insecure households under today's extraordinary circumstances. What is harder to understand is the decision by many governments to lower taxes on energy and fuel. A majority of the G7's members (Canada, Italy, France, Germany, and the United Kingdom) have taken this step, and similar measures are popular in Central and Eastern Europe, where households have been hit even harder by rising heating costs.
The problem, of course, is that subsidizing fuel reduces the incentive to save energy and distorts the price signal needed to make the economy less carbon-intensive. It is also much more burdensome on public budgets compared to means-tested transfers to vulnerable households. But sweeping subsidies are simpler to implement and more popular with voters, so politicians have seized on them. Similarly, while poorer households are the ones that need help coping with rapidly rising interest rates (a development that caught even many economists by surprise), governments feel tempted to help everyone. Rather than focus on those who have lost their jobs or are temporarily unable to service their debts, they are exploring larger-scale interventions that could pay off in the next election. Poland's government, for example, introduced an across-the-board debt-servicing moratorium on July 7, 2022, allowing all Poles with a mortgage covering "own use" real estate to avoid repayments for eight months. The National Bank of Poland and the Polish Bank Association estimate that the policy will cost the banking sector $4-5.4 billion. This type of a moratorium is highly distortionary, and it comes on top of, and in response to, another distortion: Excess liquidity in the banking system has kept deposit rates very low, thus creating the impression that banks are unfairly raising interest rates on mortgages and other loans. While the moratorium is especially costly for the banking sector in the short run, its fallout will be felt more widely. For starters, it is a highly regressive policy that will disproportionally benefit larger property owners. It also might weaken the monetary-policy transmission mechanism, dampening the effect that higher interest rates have on economic activity and forcing the central bank to raise rates even higher in the future to achieve the same effect. And by creating the expectation that the government will announce a debt holiday whenever there is a shock, it introduces moral hazard. In that case, banks may well increase the costs of their loans to price in the likelihood of future moratoria. A much cheaper and more sensible measure is the "Borrowers' Support Fund" that Poland also expanded in 2022 to support those who lose their job or whose mortgage costs exceed 50% of their household's monthly income. The fund has been financed with bank contributions to the tune of $400 million. By extending its coverage to more households in need, policymakers could avoid many of the aforementioned distortions while still protecting the most vulnerable. Of course, this approach might not provide as big a boost for the government at election time. At this point, the "new normal" has been discussed for so long that some policymakers have forgotten basic economics. They have convinced themselves that it is possible to increase public spending without identifying any means to pay for it, and without having to worry about the signals they are sending to markets; or that lower interest rates will bring lower inflation (as Turkey's president apparently believes); or that price controls do not lead to shortages. But just as we cannot wish away gravity, nor can we escape the laws of economics. Sooner or later, the day of reckoning must come. The irony is that Ukraine - the country that actually is at war - has continued to focus on its long-term future. It was servicing its external debt until very recently, and it then asked for rescheduling to avoid a default and all the long-term consequences that would come with it. It is also already preparing plans for its reconstruction, even though no one knows when the war will end. Ukraine knows what a wartime economy feels like. Shame on those who are not at war and yet lose sight of the future.
From Project Syndicate
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