"Uncertainty and fear can kill the economy"

Ori Heffetz / Photo: Yossi Zamir
Ori Heffetz / Photo: Yossi Zamir

Cornell University and Hebrew University behavioral economist Prof. Ori Heffetz, an advisor to Israel's Prime Minister, advocates reducing uncertainty through transparency and economic assistance.

"The coronavirus economic response plan that was brought before the Israeli Knesset this week [which includes a conditional commitment to a full year of support to workers and businesses] gets many things right," says Professor Ori Heffetz. "First and foremost is the plan’s long horizon. It provides a year-long safety net to hundreds of thousands of affected Israelis. That already is a big deal. It’s not enough to ensure that affected families have money to put bread on the table, pay the rent, and pay the bills next month. One should also give families a guarantee that they will have enough money in the coming months, even if the economic situation doesn’t improve quickly.

"This is our moral duty: to do everything we can to alleviate their economic pain, and minimize their economic uncertainty, which in itself is destructive over time. But it’s also the right thing to do from a macroeconomic point of view, because this money goes back into the economy, and this certainty - that the money will also be there in the coming months - helps this money to get back into the economy more quickly, and to support aggregate demand and preserve jobs. The Israeli government’s plan tries to accomplish all of that, and to do so quickly- even at the cost of making some compromises on some of the details."

What about the claim that the extended unemployment benefits in the plan may incentivize people not to work or to get paid under the table?

"One should remember that any governmental transfer of money between people, any support to the economically needy, always has an element that interferes with incentives. That should be clear. Unemployment benefits, for example, always hurt incentives to some degree. The question we always have to ask is: what’s the cost, and what’s the benefit? In normal times, too, most societies have decided that we do want to provide social and economic safety nets, in spite of the potential effect on incentives. We concluded that it’s worth it. And in these times of corona, I think that such conclusions apply even more.

"So, yes - helping the unemployed, the self-employed, the elderly, the young - all of that may hurt incentives. But we hope that the impact on incentives will be limited. And incentives are not everything. Certainly not these days, when entire sectors have collapsed so quickly, all over the world, as a result of the pandemic. Right now we have big challenges, and a potential effect on incentives is but one of them."

Heffetz, an economics professor at Cornell University and at the Hebrew University of Jerusalem, studies behavioral economics and has been teaching macroeconomics for fifteen years. Five years ago he became a co-author of a macroeconomics textbook authored by Ben Bernanke, former Chair of the US Federal Reserve. Heffetz has also, in the past few weeks, been advising Israeli Prime Minister Benjamin Netanyahu on the coronavirus crisis economic plan, which includes, among other elements, an extension of unemployment benefits, and support for the self-employed and for small business owners. Heffetz makes clear that he cannot comment on closed government discussions. Since this interview, earlier this month, the Israeli government has announced additional transfer programs, which he did not refer to at the time.

Last month, Heffetz gave a keynote lecture in the Israeli Economics Association about the crucial importance of transparency and information during a crisis that is full of uncertainty. And that’s the theme he keeps returning to during this "Globes" interview. But we start with a different question, that has become relevant again, in light of recent talk about the possibility of another lockdown in Israel.

It’s fear of the virus, not the lockdown

"I’m not a physician nor an epidemiologist," says Heffetz. "I don’t know whether it takes a lockdown to stop an epidemic. But as an economist, I can tell you: it doesn’t take a lockdown to kill an economy. There’s a certain misperception out there regarding the two curves - the health curve and the economics curve - as if there’s a simple tradeoff, as if flattening the infection curve interferes with flattening the economics curve. As if, if we lock everybody down at home, nobody will get infected but the economy will die, and if we do not impose a lockdown, the economy will be unaffected but people will die. This, more or less, has been the tradeoff story, but it’s a misperception. Because the economy can die even without any lockdowns."

Please explain

"Imagine that the Israeli government imposed no lockdown. People would increasingly get infected, some would die, and the public would react: stop showing up to work, stop going to the mall, start being cautious. This too could stop the economy or, more accurately, it would stop certain sectors but not others. People would stop going to restaurants but keep going to the grocery store.

"So it’s simply not true that had countries imposed no lockdowns, their economies would have been OK but their people’s health would have suffered, and that it’s the lockdowns that caused all the economic damage. We would have to pay a large economic cost even with no lockdowns - possibly an even larger economic cost."

So putting public health first does not have an economic cost?

"There’s an interesting study by Danish researchers, comparing Denmark and Sweden, two similar neighboring countries, during three and a half weeks in March and April, when Denmark had a lockdown while Sweden took a much lighter approach. The researchers had daily data from a big bank on credit, debit, and ATM transactions and electronic wires. During that period, the relevant household expenditures decreased 29% in Denmark, and 25% in Sweden. That’s not very different."

"In other words, I don’t think it’s mostly the lockdowns that destroy an economy. Fear of the virus - justified or not - can destroy an economy too. With or without lockdowns. Was a full lockdown necessary in Israel? How comprehensive? How strict? How long? These are good, but different, questions."

If the virus is what destroyed the economy, then, from an economics perspective, shouldn’t we devote many more resources and attention to stopping the epidemic?

"From a public-health point of view, of course we should devote the resources for upgrading our systems, including the healthcare system. From an economic point of view, anything we can do to facilitate returning to normal life has what we economists call a very high return."

When the world turns upside down: the rules of the game have changed, and people do not know what to expect

Our economic behavior, Heffetz reminded his listeners in the Israeli Economics Association meeting, is a function of our expectations regarding the future state of nature. In normal times, he now observes, "we are not too bad at forming good expectations regarding the future, because we’ve already been in similar situations before. After all, in normal times, the past is a great guide for the future. But this rule of thumb breaks down when the world turns upside down on us, and we find ourselves with no relevant past experiences, no good benchmarks, for forming accurate expectations."

And that’s exactly what has happened in the coronavirus crisis: the rules of the game have changed. "And now, I no longer know how to form reasonably accurate expectations, because I have no relevant experience in such a situation. Many of my past observations are irrelevant. In such a situation, people’s expectations may have a life of their own. In some ways, anything goes now."

None of this is a purely theoretical discussion. Rather, explains Heffetz, it is intimately related to our economic lives. "Take any governmental economic program or regulation out there. Unemployment insurance, city tax. In normal times, the public understands these programs and regulations and how they work. If you’re a business owner and you have been paying taxes for 20 years now, you have a general sense of how your tax liability is determined, you know roughly when you will have to pay, and how much. If you’re an Israeli mom-and-pop restaurant or a falafel stand, you do not have to fully understand the Ministry of Finance’s calculations, formulas, and tables. You don’t need to understand the fine print. You know how much you will have to pay, because you have been paying roughly the same amount every year. You can form expectations, you can plan."

"In contrast, look at what is happening now. Things are changing rapidly, with economic rescue packages and other emergency relief programs. The tables and formulas are modified, eligibility is expanded and extended. It’s all new rules. Nobody has experienced them before. In normal times, if you have been a business owner for years, you know how to make plans even if you understand nothing about accounting rules, because you have your experience to rely on. But now, you suddenly find yourself in a world in which you simply don’t know how to make plans, because the rules have changed. You’re drowning in uncertainty. So the least a government can do for you is make the new rules super clear and transparent: are you going to be eligible for unemployment benefits in six months - yes or no? Will your business be exempt from city tax or not? You have to know in order to make plans. Transparency is always a good thing; nowadays, it is crucial."

You’re asking the government to give people certainty.

"The government cannot give us certainty, that’s exactly the problem. There is great uncertainty; nobody knows what happens next. But the government should not add more uncertainty on top of that. Nobody knows, for example, what the unemployment rate will be a year from now. But there is no reason why an unemployed person should not know now whether or not she or he will lose their eligibility if the unemployment rate then is 5%, or 8%, or 11%."

How does one achieve that? Heffetz describes an idea that, in the end of the day, looks a lot like the plan announced by the Israeli government. "Design a plan that says: here’s a table. For example: as long as the unemployment rate is in the double digits, full eligibility is extended to one year. If the rate is 8% to 10%, eligibility is extended, but benefits are cut to 80% of their current level. Something like that. Make a commitment, publish the table now. That’s uncertainty that you can minimize, and that’s a lot."

The economic plan includes eligibility extension until June 2021 or 10% unemployment, whichever comes first, and 75% of the benefits above 7.5%. Is that enough? Maybe we need more brackets?

"We can discuss the brackets, the numbers, the details. But the crucial point is that Israel now has a year-long framework. That’s important. An inherent weakness of long-term commitments is that while they help reduce uncertainty, they come with a price: less flexibility. What if things improve faster than expected, and we realize in a few months that we didn’t need such a large program? What if the opposite happens, and we realize that the program wasn’t large enough? The table and the brackets are an attempt to condition the size of the program on the state of the economy. An attempt to build into the system automatic stabilizers, that provide some built-in flexibility and maintain some of the government’s ability to respond to a situation that no one knows how quickly it will end. The idea is to try for conditional certainty: if X happens, then we do Y."

Loss of trust

The topic of expectations brings the conversation back to lockdowns, or more accurately, to the decision about lockdowns. "Under certain circumstances, imposing a lockdown can send a signal that the government is on top of things, that the decision makers fully understand the severity of the situation, and that they are ready to act and do ‘whatever it takes.’ After all, for a politician, locking down a country is no small feat. So in some situations, an early lockdown can have a big reassuring impact. The authorities’ willingness to take such an extreme measure can therefore increase trust in the system---a crucial but rare ingredient these days."

"On the other hand, under other circumstances, a lockdown can signal the opposite: that the government is running scared, that things have gotten out of control, that the system is about to collapse. In such situations, a lockdown could be the last straw that destroys the last drop of hope that people have, and with it the entire economy. In this setting, a lockdown is a doomsday weapon; one should not use it unless the situation is extreme."

In contrast, in Israel, we see announcements that keep zigzagging. A cap of 50 people for social gatherings, then 250 people, then 50 again. Synagogues are exempted, family events are not.



"Because people lose trust in the system. And it doesn’t have to be that way. There’s a way to address this issue. The government could say: ‘Here’s how we decided to cap gatherings at 250 people. Here are the experts we convened, public servants, senior doctors, here are their credentials, and these were the considerations, and these were the data we analyzed.’ Of course, one cannot explain every little detail. But one should outline the principles. Say ‘Here’s roughly how we got to this number.’ Then, on the next day, when the number changes from 250 to 50, you can say ‘Guess what, new data arrived. Yesterday we told you how we reached yesterday’s decision; today we met again, looked at the new data - here they are, you can look for yourself - and we have now reached a new decision.’"

But that is not what we see.

"No, it isn’t. Again, one cannot explain everything. But one shouldn’t go in the other extreme either. These days, everywhere in the world, governments cannot leave people in a state where not only is the situation new and uncertain but, in addition, the government is not fully transparent about the decision-making process - and the decisions themselves keep changing."

"To be clear: quite possibly, changing the decisions frequently is the right thing to do, because the situation unfolds quickly, and we keep learning new things all the time. But in the absence of transparency, when someone looks from the outside, this doesn’t help them feel trustful or secure."

And what are the consequences?

"The very loss of trust and sense of security can in itself damage the economy. Because when things are so uncertain, how does the public react? Cancel that family expenditure because, who knows, we may need the money for groceries. Don’t rehire workers because, who knows, tomorrow the government may flip its decision again. Don’t develop the business, don’t invest in capital. Under extreme uncertainty, the best individual response may be to wait for the fog to lift."

"Again, there is nothing one can do about much of this uncertainty. But on top of that basic uncertainty, there is another tower of uncertainty piled up by policymakers. And there are things one can do about some of this additional uncertainty."

A pretty broad consensus

We end the interview discussing the macroeconomic picture. The economic response plans announced by governments may help instill some certainty and security, but they come with a price tag. In Israel, the cost is in the tens of billions of shekels, and means an increased government deficit.

We’re accustomed to talking about the need to bring the deficit under control and to insist on fiscal responsibility.

"And I fully agree with that, if we just add the words ‘in normal times.’ We must worry about the deficit in normal times. Fortunately, over the past few decades, Israel managed to bring its debt-to-GDP ratio down to a relatively low level. So when this crisis started, Israel was relatively well-positioned, macroeconomically. Fortunately, since Israel got burned in its economic crisis in the 1980’s, fiscal responsibility is in the Ministry of Finance’s DNA. Fortunately, in normal times, there is someone protecting taxpayers’ money. But when a bomb the size of this crisis goes off, Israel’s debt-to-GDP ratio is not my biggest worry. When the economy is hit by a global economic shock of this magnitude, the macroeconomic policy reaction also has to be of extraordinary magnitude. And, by the way, on this issue, most macroeconomists speak in unison, more or less. There is a pretty broad global consensus out there."

Does this mean that Israel has more flexibility now in thinking about economic packages of the magnitude you’re talking about?

"Yes, it does. Due to the justified concern Israel typically shows regarding its budget deficit and its debt-to-GDP ratio, it can afford more nowadays. I think that Israel’s deficit concerns are fully justified in times of low unemployment and fast economic growth. But in times like this, we have to think differently. This crisis forces us all to think outside the box, to think boldly. We have to realize what world we’re living in now. It’s a very different world from the one we typically live in. I hope we return to that world as soon as possible."

Published by Globes, Israel business news - en.globes.co.il - on July 22, 2020

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

Ori Heffetz / Photo: Yossi Zamir
Ori Heffetz / Photo: Yossi Zamir
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