COVID-19’s exponential growth has already offered the public a crash course in numeracy. It is also proving to be a crash test for systemic risk. While it is too soon for the final verdict, it is already clear that the U.S., not only its current leadership, will need a significant overhaul.

Taking systemic risk seriously is the ultimate governance test. Those who pass it know to shut down a city or an entire country when there are still only a few cases of a highly contagious virus present. Sara Cody, the public health officer for California’s Santa Clara County, and New Zealand Prime Minister Jacinda Ardern did precisely that in the face of COVID-19. Their decisive risk management has paid off in spades.

It also helps to have political leaders with a science background, judging by Germany’s success in managing the crisis under Chancellor Angela Merkel (a trained chemist), or Ireland’s under Prime Minister Leo Varadkar (a physician). And the fact that a disproportionate share of the most effective strategies has been implemented by governments led by women surely is no coincidence.

Disastrous response

The death tolls in jurisdictions that were slower to respond, such as New York City, are far higher. At the national level in the United States, President Donald Trump’s disastrous response to COVID-19 also can be directly ascribed to a failure to appreciate risk, beginning with the Trump administration’s 2018 decision to dismantle the National Security Council’s pandemic-response team. It is now abundantly clear that science- and intelligence-based risk assessments are crucial for effective political leadership. Trump habitually subordinates both to his “gut” instinct.

The U.S., of course, holds no monopoly on incompetent leadership, and even effective individual leaders can do only so much. Systems matter, too.

The U.S. has long laid claim to one of the world’s most dynamic economies, owing to its emphasis on flexibility and efficiency. But, as the Nobel laureate economist Joseph E. Stiglitz has observed, in times of crisis, the lack of “shock absorbers” implied by U.S.-style dynamism becomes painfully apparent, to say nothing of rampant inequality.

After the COVID-19 pandemic has passed, the U.S. and many other countries will need to fortify their defenses against a wide range of hitherto underappreciated risks. That must start with bolstering national and multilateral epidemic-response capabilities, not least by increasing investment in the U.S. Centers for Disease Control and Prevention, the World Health Organization, and other relevant agencies and institutions.

Other ‘big ones’

But deadly pandemics represent just one of many possible threats looming on the horizon. Other potential “Big Ones” include: an all-out cyber-attack; a solar storm on the scale of the 1859 Carrington Event (which wiped out terrestrial communications infrastructure); a massive earthquake in, say, Tokyo or the U.S. Pacific Northwest; or any number of disasters stemming from climate change.

When thinking about risk, probabilities matter as much as the potential impact. Shortly after the terrorist attacks of Sept. 11, 2001, then-U.S. Vice President Dick Cheney devised what would become known as the “one-percent doctrine,” arguing that, “If there’s a 1% chance that Pakistani scientists are helping al-Qaeda build or develop a nuclear weapon, we have to treat it as a certainty in terms of our response.” Although Cheney was ignoring probabilities and mostly engaging in political theater, his statement comes close to how governments should be thinking about systemic risk.

In the U.S., the government already assumes this role for some risks: two examples are the Strategic Petroleum Reserve and the Strategic National Stockpile of medical equipment. But merely creating such institutions is not enough; they also need to be managed competently, as the failures of the medical stockpile in the current crisis show.

Moreover, the government has a duty to mandate that the private sector maintain redundancies to provide resilience against systemic risk. Banks are subject to minimum reserve requirements for good reason. (Yet here, too, there is room for improvement. Policymakers should finally heed the lessons of Long-Term Capital Management’s collapse in 1998 and bar banks from shifting their risks off their own balance sheets and onto those of hedge funds and others.)

Corporate bailouts

True reform of risk management must go even further. For starters, the U.S. and other governments around the world need to stop socializing risks without also socializing returns. There should be no corporate bailouts without a public equity stake; private creditors should be the first to be wiped out.

Few faulted Warren Buffett for negotiating favorable terms on which to invest billions of dollars in Goldman Sachs GS, -2.87% and Bank of America BAC, -2.84% after the 2008 crash. Government, operating on behalf of the public, ought to be the most sophisticated investor of them all.

Finally, as an insurer and investor of last resort, it is entirely appropriate for government to lead a temporary but radical reorganization of the economy when circumstances call for it. Whether it be in response to a pandemic or a larger but slower-moving crisis like climate change, the government must price risk across the board, and ensure that financial, energy, health, and transportation systems are operating in the interest of broader social priorities.

Despite being eminently foreseeable, COVID-19 has surprised just about everyone, exposing our lack of preparedness. With other foreseeable catastrophes on the way, there is no excuse to postpone building resilience. Giving systemic risk its due inevitably will invite pushback. Resiliency implies redundancy, which is often perceived as the opposite of efficiency. But that is true only if one adopts a limited time horizon or ignores external costs altogether. Governments should do neither.

If COVID-19 has taught us anything, it is that delaying prudent policymaking does not merely result in higher marginal costs down the road. Rather, it puts us on an entirely different trajectory — one that all too easily can end in catastrophe.

Gernot Wagner teaches climate economics at New York University. He is the co-author, with the late Martin Weitzman, of “Climate Shock: The Economic Consequences of a Hotter Planet.”

This article was published with the permission of Project Syndicate.

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