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Assess The Micro And Macroeconomic Impacts Of Covid-19 On A Country Of Your Choice
The economic impacts of the COVID-19 pandemic on Germany
Date : 01/07/2020
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Uploaded by : Nadir
Uploaded on : 01/07/2020
Subject : Economics
Within the German economy, the pandemic could cause fundamental structural changes in its microeconomic markets. With significant falls in demand across industries, led by the travel and hospitality sector, and assuming initial conditions of monopolistic competition, a fall in market prices is occurring, causing an inward shift of firms demand curves and falling revenues. Firms with insufficient collateral will be unable to cover their short run average variable costs and hence shut down, leaving a few established firms that have sufficient collateral standing. In the long-term a more concentrated, possibly oligopolistic, market will develop with these few firms when demand begins to rebound.
Given that the travel and hospitality industry contributed 8.6% of Germany s GDP in 2018, the market power of firms emerging from this pandemic combined with a surge in demand following months of travel bans could result in widespread market failure, where producers take advantage of price inelastic demand and irrational consumer behaviour to maximise their surplus. These firms could choose to collude covertly, knowing that cartel formation is an administrative offence in Germany, and charge prices above the socially optimal level. German consumers may have to face higher prices and suffer welfare losses in the long-term due to shifts in market structure.
The application of this logic to the wider economy must be carefully considered. Firms whose products have become necessities as a result of the pandemic, such as digital software and medical equipment manufacturers, will experience growth in demand, an example being German firm Teamviewer which provides video conferencing services and remote IT maintenance. Firms drawn to the possibility of profits would enter the market, if barriers to entry are low and markets contestable. Depending on initial market structures, this could lead to increased competition and improvements in X-efficiencies by firms attempting to remain competitive. Consumers would then benefit from lower prices and increased surplus, opposing the initial hypothesis.
Other exceptions are already oligopolistic industries such as the air travel industry, with a 65% 5-firm concentration ratio as of 2017. The IATA stated in its 2019 report on German air travel that supply chain competitiveness is necessary to maintain low fares and stimulate demand. However, given regulatory interventions causing supply-side instabilities during the pandemic, the level of uncertainty facing airlines has shifted the focus from competitiveness to breaking even with unprecedented consequences. For example, oil prices have gone negative for the first time in history as airlines, amongst other industries, cut costs and delay purchase of this key component in the aviation supply chain. Airlines such as Lufthansa are struggling to break even and it has stopped paying shareholder dividends to preserve solvency, indicating a shift in its business objectives and possible divorce of ownership from control. Despite an already oligopolistic air travel industry, well-established airlines are struggling to remain solvent due to the crash in demand depriving them of revenue and financial capital. Virgin Australia, Australia s second largest airline, entered voluntary administration in late April the same fate could overcome German airlines.
Many firms including Lufthansa have considered seeking government assistance due to the steep decline in revenues. The airline industry contributed 2.5% of German GDP in 2018 allowing such a crucial industry to collapse will weaken future export earnings and reduce the current account surplus. Governments worldwide have committed to record-breaking stimulus packages to keep their economies moving and maintain the circular flow of income through fiscal injections. Germany is no different, and in fact has the largest fiscal stimulus as a percentage of GDP in the EMU of 23%.
The German finance minister Olaf Scholz pledged unlimited loans by the state development bank KfW and the deferral of billions of euros in corporation tax payments, a set of measures described as a bazooka . Scholz also agreed to a 750bn fiscal stimulus for the German economy the federal government s supplementary budget of 156bn will be financed through borrowing and used to finance social spending including doubling intensive care capacity. Such an immense injection into the circular flow of income will have positive multiplier effects for the economy, offsetting some of the fall in aggregate demand and real GDP. The proposed stimulus will reassure investors who could choose to invest with greater confidence, further raising aggregate demand.
Nevertheless, economists may be concerned with the long-term impacts of the fiscal package. Dependency of firms on government assistance may lead to productive and X inefficiencies, and companies may lobby to retain fiscal support even if not necessary in the future. The opportunity cost would be significant because these funds could be spent on infrastructure, for example, instead of bolstering inefficient sunset industries. Beneficial future expenditure plans may be delayed due to the magnitude of contemporary government borrowing. Failure to repay loans may also lead to a loss of creditworthiness for the German government as a debtor, again compromising its future ability to borrow and spend. Consequent austerity measures, post-pandemic, could limit the future growth rate of the economy by reducing aggregate demand, leading to the economy operating with spare capacity.
A loss of capacity may, however, be a greater issue than spare capacity. Despite employment figures for 2020 thus far not reflecting it, Germany s unemployment rate has increased dramatically following temporary and permanent business closures Lufthansa had 138,353 employees in December 2019 and, having furloughed 90,000 staff, over 65% of staff are now claiming wage subsidies. This will place the fiscal budget under further strain due to greater social transfer payments and income tax revenue losses, pushing Germany back towards a fiscal deficit. Moreover, hysteresis will damage growth prospects workers unable to work remotely or practice their profession may lose vital skills, reducing the economy s long-term productive capacity. Long-run aggregate supply (LRAS) will fall at any given price level and it will take time to recover lost capacity during the recovery phase, growth will be restricted and, utilising a Keynesian LRAS model, any demand-side stimulus could prove to be inflationary if the economy is operating near full capacity post-crisis.
Productive capacity is an issue not only in Germany due to global supply of healthcare equipment being price inelastic at the start of the pandemic, increases in capacity of global manufacturers such as 3M have been gradual. The resulting excess demand in the market for FFP2/3 masks led to a trade dispute where Germany accused the US of modern piracy it claims that the US seized 200,000 masks in Thailand, due to be delivered to Germany, for diversion to the US.
As economies begin to reopen and if similar disputes are replicated between many economies, tensions may spill over into global trade. Economies could be more hesitant to open to trade and instead introduce protectionist policies such as quotas or tariffs, similar to the isolationism seen during the Great Depression. Domestic firms would then face less competition from foreign firms and could develop inefficiencies, prompting higher costs and reduced choice for German consumers. Isolated economies would no longer benefit from comparative advantages available with open trade as postulated by Ricardian theory, instead relying on more inefficient domestic industries. Retaliatory measures could also be put in place by other economies, leading to export earnings falling this would restrict growth in the German economy given that its foreign trade quota was 84.4% in 2018.
In order to limit the negative impacts of COVID-19, Germany s federal government must allocate its debt-financed budget wisely using all available data to ensure that crucial sectors are protected and can receive export earnings as the pandemic clears. Consumer and investor confidence are also paramount to maintaining aggregate demand and real GDP consumption and investment formed 52.14% and 22.0% of GDP in 2018 respectively. Competition authorities in Germany should ensure that markets remain competitive through low barriers to entry and exit and greater contestability in addition, firms both essential to sustaining competitiveness and on the brink of insolvency should be identified and granted the necessary financial assistance by the federal government to remain functioning. In the long-term, bolstering good relations with trade partners will facilitate a faster amelioration of the German economy isolationism will hinder its growth, whereas the benefits of open trade include improved competition, efficiency gains and lower prices for consumers.
Targeted government intervention in key sectors, stimulating competition and maintaining trade among other economic policies are pivotal to the German economy`s rapid recovery from the impacts of the COVID-19 pandemic.
This resource was uploaded by: Nadir