The Long Road Ahead

What can policymakers do to ensure their nations—and the world—prosper after the Covid crisis passes?

Every autumn, political and economic decision-makers from around the globe have gathered at the World Bank-IMF meetings to discuss problems and share insights with their peers.

This time it’s different.

It’s not just that the “meetings” on October 12-18 will be virtual, with no casual exchanges between central bankers in the corridors, and no cross-border connections made at the buffet. A global pandemic threatens not just growth, but the basic functioning of many economies—as well as political stability and therefore governments.

“The scale of this crisis is without parallel in recent history,” comments Ignazio Visco, governor of the Bank of Italy. GDP levels even in the largest advanced economies will remain around 3% to 4% below their previrus trend paths by the middle of this decade, according to Fitch Ratings. “A sudden and deep economic crisis has started, with a recovery path still unknown,” says Gonzalo Gortázar, CEO of CaixaBank. “This has put a tremendous stress on many sectors.”

The damage, hardly yet measured, will be lasting. “There’s a lot of evidence from history that very large shocks to economies have a lingering impact on growth,” says Brian Coulton, chief economist at Fitch, noting that one long-term risk is that unemployment destroys human capital. “This shock is not going to dissipate quickly in the way a normal recession would.”

Permanent Changes

The pandemic has also turbocharged economic dynamics, exacerbating global inequality trends. “The most affected are our most vulnerable neighbors—those who don’t enjoy paid sick leave, can’t work from home, or don’t have much cushion in their savings accounts,” Federal Reserve Bank President Charles Evans acknowledged in August. “Their future is highly uncertain and will require new policies.”

A similar dynamic is at play at the country level, with emerging markets harder hit, generally speaking, than more advanced countries—although China, first to confront the virus, is the only real bright spot. “Latin American countries will emerge from this crisis more indebted and facing more social inequality,” predicts Brazil Central Bank President Roberto Campos Neto.

With either ironic or fortuitous timing, this year’s World Bank-IMF meeting coincides with the Northern Hemisphere’s flu season—and a potential second wave of infections, feared to be more deadly. Health—both human and economic—will undoubtedly be at the front of everyone’s mind. World Bank events this October include sessions on human capital, the common good and a “just recovery.” “I think this whole inequity issue, the rich-poor divide, is going to be uppermost in the minds of governments and people in the next five, 10 years,” says Piyush Gupta, CEO of DBS Bank.

The Basic Conundrum

As the deadly realities of the novel Covid-19 coronavirus emerged in the spring, public health called for drastic and expansive quarantines; yet the measures would of necessity snuff out much economic activity, especially local economic activity, at least temporarily. Many private sector actors stepped in to help. CaixaBank, as just one example, advanced unemployment and pension payments, gave rent holidays and waived many fees.

Yet even more than other upheavals, the coronavirus called for major public spending: on health care; on mitigation; on vaccine development; and to keep the citizenry and commercial enterprises afloat through various levels of “lockdown,” on economic activity.

Administrations, legislators and central bankers dug up ordinary and extraordinary tools. South Korea delivered its people 270 trillion won, passing no less than three supplementary budgets to meet the challenge. As of July, Japan led the G20 in spending, with outlays of 117 trillion yen—more than 21% of GDP—in response to the crisis, according to Statista. Canada came in second with 15%; and Mexico last, at less than 1%. In the US, a burst of public spending helped perk up disposable income during the first months of the coronavirus. The country’s building industry, supported by the low cost of money and a renewed demand for relocations, is doing extremely well.

“The developments in financial markets suggest that the actions of monetary authorities managed to control volatility in the markets—although with a higher level of risk for the entire block of emerging economies,” says Mario Marcel Cullell, governor of the Central Bank of Chile.

Awkwardly, however, the pandemic came after years of stimulus—ultralow interest rates, asset-purchase programs and tax cuts—leaving many central banks and governments with precious little policy space to act in this newest crisis. Many of the most vulnerable countries are hard-pressed to take on more debt. In Latin America, infections are soaring; and the IMF projects as much as a 9% fall in output this year—on the order of two million company bankruptcies and 30 million jobs lost.

“Latin America is not as well-prepared to deal with this situation as previous epicenters, like China, Southern Europe and the US, because we’re not in a position where we can do whatever it takes,” said Mauricio Cárdenas, a former finance minister for Colombia, in a Wilson Center event in June. “We all have limitations, mostly from the fiscal point of view; but we also have limitations that have to do with the initial health infrastructure, with the operational capacity of our governments that are slower to react and to respond, [and] the lower coverage of our social safety nets.”

High levels of debt, meanwhile, are raising some concerns about inflation. Moody’s expects the debt burden for EM economies to increase by an average of 10 percentage points of GDP between 2019 and 2021. Some financial analysts are already planning for possible debt defaults or major restructurings in Africa or Latin America. Most emerging countries will see “a sharp deterioration of the fiscal space, with the weakest facing severe funding pressure,” says Elena Duggar, Moody’s associate managing director.

Debt is rising fast in developed markets, too. Moody’s ratings agency predicts the average debt/GDP ratio for 14 advanced economies will rise twice as much this year as it did during the 2008 global financial crisis. Indeed, this past summer, advanced economies’ debt reached an average of 128% of GDP—above the level in 1946, in the aftermath of World War II. Debt hawks worry about inflationary impacts.

Yet the debt hawks must reckon with Japan, where debt has risen beyond 240% of GDP without causing undue problems. “The Japanese people believe that the Japanese government is serious about getting the debt down,” says David Andolfatto, senior vice president at the Federal Reserve Bank of St. Louis, adding that this is lost now in the US. “The bipartisan support for managing the debt going forward kind of evaporated.” For the US, historically large demand for T-bills—extensively used as collateral in the financial markets and for regulatory purposes by Basel III and the Dodd-Frank Act—has so far been a solid backstop to rising US debt.

“As long as that demand for the US dollar and US Treasuries continues, I think we can continue along this path,” says Andolfatto. “The million-dollar question for me is, What is going to happen when that demand slows down?”

Having a sovereign currency is useful. “A lot of the [advanced country] currencies act as a safe haven, so rates are going to be very low,” says Moody’s Duggar. “That means the debt-servicing costs on their debt will remain very low.”

Structural Change

In addition to its immediate impacts, the coronavirus outbreak has accelerated some long-term trends, largely technology centered, that are restructuring the global economy and also tend to exacerbate inequalities. The pandemic has turbocharged the technology sector, for example, because it supports remote work and online shopping. Google, Apple and their ilk have propped up US markets for months. Just as tech-enabled workers in knowledge-based sectors are able to continue to work from home, countries with strong tech and high-value-added economies are getting something of a boost from the pandemic.

On the other hand, nations that rely on tourism or commodity exports are taking the hardest hits. In short, rich economies are surviving better and are likely to emerge stronger, while weaker economies are harder hit and less likely to rebound—a so-called K-shaped recovery.

Covid’s challenges face all countries, including developed ones. Commodity prices are low and expected to remain so. That hurts commodity exporters, whose ranks include developed nations such as Canada as well as Colombia and Russia. Nations with heavy dependence on tourism will also lose big; those include Spain, Italy and Portugal as well as much of the Caribbean. Countries that rely on remittances, such as Mexico or the Philippines, are also in trouble.

But emerging markets are most likely to be hit on multiple pain points: tumbling commodities prices and exports, falling remittances, evaporating tourism and rising debt costs. Some frontier market countries, such as Angola and Zambia, saw yield spreads soar, Duggar notes, “a perfect storm.”

Some changes will be permanent features of a new normal. In June, The Conference Board found a majority of 1,316 C-suite executives worldwide—and especially those in companies with revenues of $5 billion and above—see the pandemic as a long-term opportunity to rein in costs. A smaller permanent workforce, a larger contingent workforce, less office space and smaller travel budgets will be more common in the postpandemic world.

Such a digital transformation could give long-term productivity a boost. For example, telehealth, or remote medicine, practiced of necessity during the pandemic, may deliver unexpected benefits in healthcare. “In the next three to five years, digital transformation will accelerate,” says Ataman Ozyildirim, director of economic research and global research chair at The Conference Board.

But both technology and innovation will most likely impact only a part of the population. “It seems that the pandemic really exposes the risk implications of the inequalities across economies and within economies,” says Ozyildirim. “It is affecting different groups in the labor market differentially and those problems can be getting worse.”

At the international level, too, after years of economic convergence, disparities could start to widen again. “First estimates indicate a continuation of the positive growth gap between China and the West, which is the same evolution that largely shaped global inequality in the past four decades,” Branko Milanovic, a professor at CUNY and an expert in socioeconomic inequality, wrote in June. If the virus drives poor and middle-income countries like India, Brazil, Nigeria, Congo and Indonesia into contraction,  that conversion may be reversed, he wrote.

Increasingly, corporate leaders want to address those issues, too. “I’m convinced that one of the big things coming out of this pandemic is a much greater focus on ESG; and within ESG, there’s going to be a much bigger focus on the ‘S’—the social issues. Because everybody has seen, through the pandemic, that inequality issues all come to the fore,” says DBS’ Gupta. Furthermore, he adds, “When you start focusing on inclusion, when you start focusing on democratizing solution sets, that actually creates a lot of new opportunity.”

Simon MacAdam, senior global economist at Capital Economics, expects that by the end of 2022 many countries will have stabilized, with GDP somewhere from 1% to 10% lower than without the crisis. Developed economies and richer developing ones such as China, Japan and Taiwan will lead and get closer to former growth; while much of Latin America, South Africa and India will underperform nearer the 10% end of the range. “The broad point is that advanced economies are going to be in a better position than emerging economies,” MacAdam says.