24 March 2020

Microeconomics lesson: individual incentives in time of crisis

Radu Muşetescu

The measures package recently adopted by Romania’s government to support the private sectors, as well as the associated social assistance, has a microeconomics approach. Although they could have talked about other types of measures as well, this package could be a starting point to the right direction. However, such approach must necessarily come up with a microeconomics measures package, by which to align the individual incentives to the public policy objectives. This can prevent the useless individual behaviors, as well as systematic failures during the crisis. In the end, the national and international economic and financial measures announced when the pandemic started are quite new and sometimes even spectacular by the objectives they propose. Considered an unexampled crisis since the First World War, it is forcing all governments to navigate on turbulent waters. And take similar measures.

Image source: Mediafax

The biggest dilemma when it comes to crises is its duration. This is also available for the current crisis generated by the COVID-19 pandemics. Romania’s government must consider all possible scenarios regarding its development. In fact, the First World War lasted, in Europe, 4 years, although the world thought the war was going to end in a few months only, before the 1914 Christmas. Romania fought for two years. The Second World War lasted six years, although the German Wehrmacht thought they will defeat the Soviet army in 3-4 months. This is why the German troops did not have winter equipment. If the current pandemic extends for two months (at least as crisis and prevention management measures, not to mention the economic impact), its challenges can be compared to a war situation.

When talking about the official data related to the pandemics (which is the crisis), the time between adopting firm quarantine measures and the lack of new cases was, in the Chinese Popular Republic, two months. Starting this week, we could speculate, by applying the scenario of a similar period, that things may get back to normal in Romania, by May, from a medical perspective and in a medium to optimistic scenario. In order to reach such desideratum (any other positive event would not but shorten this period, any other negative event will extend it), it is essential for the public institutions to successfully manage the crisis, firstly the health and security systems (by involving the Ministry of Home Affairs and the Ministry of National Defence). If thanks to complex specific and different factors from ours, the Chinese Popular Republic’s institutions employees had an exemplary behavior, in a democratic society and a market economy like Romania’s, the useless and opportunistic behaviors must be controlled. And the economic tools are essential to that end, even more than the legal-punitive ones.

A few days ago, there was a story in the media about some doctors in Bulgaria’s capital, Sofia, who had resigned because the hospital did not have the necessary equipment to protect them. Although the story was not officially confirmed (only AlJazeera and other secondary sources reported it), the information can remind us of the risk posed by state authorities in motivating the personnel working for key institutions to help the crisis management. This situation seem to replicate difficulties of local American authorities in keeping the public order during the crisis generated by Katrina, in 2005, when most of the order forces from New Orleans did not come to work. Until the federal forces’ interfered, things got out of control in some areas in Louisiana.

The average salary of a doctor in Bulgaria is 550 euro. The government recently promised (after the seeming resignation) a similar bonus during the crisis. If there is something we could say about the economic policies we have witnesses in the last couple of years, it would be that the average salary increase in the medical field has bested this level. Having salaries that are bigger than 2.000 euro, the Romanian medical personnel has, according to some estimations, around 60.000 doctors, therefore their salaries would cost about 120-150 million euro per year. Most likely a quarter of this people will be in the first line of the pandemic fight (in a maximal scenario).

Basically, an economist would say that wars or crises are won through correct incentives to people involved in process’s management. Crises are successfully past by institutions who really work and by the resources they have.

If breaking a rule costs 1 RON, people will react in a certain manner. If the punishment if 1.000 RONs for the same rule, their behavior would be different. If the rules may seem absolutely similar, there may be major behavioral differences between two societies thanks to the same incentives (positive or negative).

Besides the economic impact, the behavior of those who are “in the first line” is essential for the current management of crisis: the medical personnel but also, more importantly, the personnel that works for the internal security and public order. These personnel must be willing to act decisively, to take risks and stay on the “battlefield” in difficult situations.  And the economic incentives can de determinant. One first recommendation for the governmental policymakers applicable applied to all medical and force institutions in Romania:

-offering a bonus of emergency/necessity situations, whereat to add the salary of the personnel involved in managing the crisis. Such a bonus would only apply to those employees who are in the “first line” of epidemic’s fight, on the streets or in hospitals. Such a measure should not be applied to all employees from the mentioned institutions.

-creating life insurances for the employees involved in the activity that calls for direct risk. The first should be paid by the Romanian state, if the private insurance societies would be willing to subscribe (why not? for a fair price, especially when talking about a crisis situation of this field) or if such societies would not respond, Romania’s government should create its own block grant to that end. The costs would be reasonable, but the impact on employees’ behavior would be major.

Most of the Romanian soldiers enlisted by the Romanian state in the First World War, the war that led to one nation’s dream, did it for patriotic and economic reasons. They were promised land by Ferdinand King, on March 23th 1917, during a visit on the Racaciuni front. And they got the land: two months after that, the Parliament started the landed reforms. In three years, more than 2 million hectares were distributed to farmer soldiers, heroes of the Romanian nation. Such events are relevant proofs of Romania’s political leaders’ ability to acknowledge that aligning individual incentives with public policies must also go through economic filters.

Behind today's "front line", there is the "internal front": public utility services related to critical infrastructure. It is absolutely necessary, depending on the duration and severity of the crisis that Romania will face, the qualification of some professions/services as critical. They cannot be postponed or let go.

The program that provides, during the period of technical unemployment, 75% of the average salary must come with the provision of services to community, considering the allowed health limits. Local authorities can call on these people to carry out public utility services (food delivery for those quarantined, assistance to the elderly, support of the Home Affairs Ministry in maintaining public order, supporting the activities of medical personnel, etc.).

Let us not forget that the fundamental reason for economic efficiency was duplication avoidance. Infrastructure companies were happy if they minimized the employees’ number per hundred customers. Or, during crisis times, when we talk about the possibility of the physical unavailability of certain people, their role and functions must be duplicated in a way that allows the services’ security and stability.  

Let's take a hypothetical case: an electricity fall in a village in Romania, during the crisis. If the electricity intervention team is unavailable due to the employees’ illness, practically the unavailability of this service can lead to dramatic effects on the population (food, communication, etc.).

Given the context, paying Romanian citizens just to stay home is an aberration. They must be involved in training and instruction programs to ensure duplication of functions and pleople working in critical infrastructure areas. Even if they do not qualify as permanent workers, they army structures can acquire, within 1-2 months, the skills and abilities to fill the specialized workforce. As there are military „reserve” forces, there could also be established some "reserve" force services providers, specialized in the services provided by the critical infrastructure. The selection can be made starting with volunteering, depending on the preferences of the citizens and their abilities or the specifics of the employers. The authorities can, at any time, access the Employee Registry situation of their employees and acknowledge their specialization and their status (technical unemployment, activity, etc.).  

Companies in critical infrastructure sectors need to be supported in creating this "reserve"/duplicate employees force and those who are actively involved could also be compensated by the increase in promised revenues.

Such measures should not be regarded as a populism by which money is wasted. The crisis is unlikely to be overcome once the majority of the population is at home. Let us not forget that, in China’s case, the blocked area that was fully quarantined was only the province of Hubei, that is, the equivalent of a county for Romania. The rest of China kept working and served the affected province. This is not the case in Romania, where the whole country is quarantined, but no one works for those who stay home. Therefore, in the short term, the resources allocated from the "first line" should be taken from those who stay at home. During the crisis, any reduction in spending can help in an important way, if it does not endanger the living standards of the population. Government programs that allocate important resources such as Start Up Nation, First House or Rabla should be re-evaluated and postponed until after the crisis (however, many local authorities do not work as well). Limiting pensions (like 2 average salaries per economy, etc.) could also help a lot.

However, estimating the macroeconomic impact of crisis management costs and discussing solutions to cover them is another analysis challenge that we will not address here. However, macroeconomic analysis must be associated with such studies, at the microeconomic level. Ignoring the individual behavior, given the "matching" macroeconomic figures, can provoke different social costs.

Translated by Andreea Soare