“Everyone thinks of changing the world, but no one thinks of changing himself”.

- Lev Tolstòj

COVID-19 will not change the world for the better. Those who dislike capitalism, immigration and pollution hope the virus will end them all at once. Yet, previous crises have shown that change is hard to achieve. Only a decade ago, the 2008 global financial crisis (GFC) led to similar calls - to no avail.

A dangerous status quo. Change is needed. In the absence of bold decisions, rising inequality will foster populism and nationalism, putting democracy at risk (Figure 1), as follows:

First, growth will remain below-potential. The deepest recession in a century will: i) freeze aggregate demand and keep ‘consumer good inflation’ below central bank (CB) targets; and ii) force activity reshoring and shorter supply-chains, inflicting lasting damage to labor productivity and potential output. For years to come, growth and incomes per capita will be lower than in 2019 - across the world. A V-shaped recovery is improbable.

Second, three more crises are likely to unfold. In the fall of 2020, a social crisis will require governments to protect jobs and mitigate the recession’s social costs (e.g. unemployment, mental health and domestic violence). In 2021, heavily-leveraged companies and countries may endure a debt crisis. As a result, a banking crisis might ensue.

Third, CBs have no alternative but to print. To cushion the crisis and finance the recovery, CBs will be the only game in town. Unconventional monetary policy will fund: 1) growing government deficits (i.e. salary, healthcare, and pension liabilities will increasingly be paid with freshly printed money – aka debt monetization); and 2) financial institutions, including insolvent ones (i.e. zombie banks) and established market participants (e.g. systemic investment management firms). Liquidity will be allocated along existing power structures: profit- and rent-seekers will benefit disproportionally more than wage-earners.

Fourth, Statism will rise. Financed by CB liquidity, the role of the State will grow. Economic intervention in ‘national-interest sectors’ (e.g. energy, telecommunications, health-care and pharmaceuticals) will be seen as necessary. State-owned enterprises (SOEs) and stricter regulations will acquire legitimacy – likely leading to an inefficient allocation of resources.

Fifth, numbed by easy money, governments will not reform. Around the world, most governments announced ambitious fiscal plans, up to 10-20 percent of GDP. Yet, shovel-ready projects are rare and execution skills are scarce. As absorption capacity is limited and money is fungible, policy-makers will find it convenient to prioritize recurrent (e.g. salaries and benefits) over capital spending (e.g. fixed asset investments). In the presence of abundant financing, structural reforms – needed to attract long-term capital and spur competitiveness – will be shelved. In labor markets, the dichotomy between the ‘haves’ and the ‘have-nots’ will crystallize.

Sixth, inequality will rise across countries. Each nation’s trajectory will depend on its: i) political leaders’ vision and skills; ii) power structures; and iii) institutions. Policy mistakes will cost exponentially. Inevitably, economic, political, and social outcomes will diverge radically. Organized and innovative countries will come out ahead while slow and bureaucratic ones - characterized by powerful rentiers, little competition, low growth and high debt - will suffer the most.

Seventh, the ‘CB printing press’ will exacerbate the wealth gap. Money will be abundant and free for those who are creditworthy, but unavailable for those who lack the capital to collateralize new debts. “Main Street” will keep suffering from income compression, stagflation risks, and falling investments. “Wall Street” will keep benefitting from speculative leverage and asset inflation^[1]. With no “trickle-down”, wealth and opportunity gaps will rise in every nation.

Democracy is at risk. From Athens’ ‘Thirty Tyrants’^[2] to the rise of Hitler^[3], democracy always failed “from inside”. The shift towards authoritarianism was favored by: 1) rapidly changing contexts; 2) inept rulers; and 3) weak institutions. This time is no different: uncertainty, lack of confidence in the future and disrupted education will likely lead to a surge in populist nationalism. Political consensus could veer towards Hobbesian solutions^[4].

A radical change of direction is needed. It is time for an act of responsibility. GFC-like inaction should be avoided: short-term challenges must not be allowed to fester, developing into hard-to-resolve problems^[5]. Only bold vision, a clear strategy, and leadership will fix the economy and save democracy.

1. Borrow, but keep interest rates below nominal growth^[6]. In the short term, closing the deficit^[7] is not a priority: CB financing of government operations – i.e. debt monetization - is unlikely to be inflationary. In the medium term, however, increasing debt/GDP ratios is worthwhile only if debt-financed activities lead to long-term competitiveness, higher investments and sustainable growth.

2. Boost real growth, via regulated free markets. To create opportunities, employment and wealth, economic growth is the priority. In a recessionary business cycle, expansionary fiscal and monetary policies must support: 1) aggregate demand^[8]; 2) pro-growth structural reforms^[9]; and 3) international trade^[10].

3. Improve the welfare state, deepen democracy. Despite its shortcomings, the welfare state remains a valid socio-economic model. Most economies need to improve their service delivery via: i) social safety nets for the distressed; ii) stronger public-health systems; and iii) modern education. To protect democracy, avoid “business as usual”: the expansion of state’s responsibilities must go hand in hand with higher accountability.

4. Save the State from Statism. If governments become more pervasive but remain unable to address citizen’s needs, discontent and alienation will grow. To build a strong, effective State – able to play an active role in enabling innovation - policy-makers need to strengthen the ‘rules of the game’ for the market to function (e.g. breaking monopolies^[11] via effective regulation, favoring risk-taking and entrepreneurship) while minimizing the State’s encroachment (i.e. cronyism, bloated bureaucracies, control over private companies). The entrepreneurial spirit and competition are public goods that need protection.

5. Cut unproductive spending^[12]. The time is now: the recession is an opportunity to improve the quality of spending – which matters more than its size. For business confidence to rise^[13], allocated resources must enhance productivity, spur growth, finance convergence and development, and improve real incomes. To achieve sustainability and defeat decadence and waste, austerity^[14] and restraint are needed.

6. As the recovery starts, normalize monetary policy. In the long run, unconventional tools (e.g. zero-interest rates, quantitative easing) do not stimulate economic activity but result in: i) excessive risk taking and asset inflation (i.e.: artificially high prices of equities¹, fixed income and real estate); ii) increased bank credit risk; and iii) financial sector fragility. Once the recovery is under way, CBs should increase short‐​term interest rates and shrink the size of their balance sheets.

Bottom line: build better societies. The post-COVID-19 crises will force CBs to print. Easy money will finance: 1) an inefficient enlargement of the State, along existing power structures; 2) zombie banks, able to lend only to the creditworthy; and 3) a bubble in financial markets. The resulting increase in inequalities will threaten democracy. To avoid the inevitable unfolding of a ‘chronicle of a death foretold’ (Figure 1), countries should fix the economy - the prerequisite for saving democracy - and re-shape the State - to offer all citizens: i) equal opportunities; and ii) economic and cultural growth.