“Pandemic depression”: The way ahead

Vincent and Carmen Reinhart

In the October/November 2020 issue of Foreign Affairs, Carmen Reinhart of the World Bank and Vincent Reinhart, Chief Economist for BNY Mellon Asset Management, have this article on “The Pandemic Depression: The Global Economy Will Never Be the Same.” They cite various data to justify the expression. Bank of England had predicted the steepest decline for UK since 1706. The unemployment figures in the US are the worst since the Bureau of Labor Statistics has had data on it. The World Trade Organization estimated that global trade is poised to fall by between 13 and 32 percent in 2020. And the World Bank had predicted that the global economy would shrink by 5.2 per cent in 2020, and that 60 million people will be pushed into extreme poverty as a result of the pandemic.

The Reinharts insist that it needs to be called a depression – a pandemic depression – notwithstanding more recent and living memories of the long and acute depression of the 1930s. This has also been the first one that governments have so fiercely combated, with lockdowns and travel bans, and large scale economic firepower.

The 2008 crisis was a banking one. And like these previous crises, were localised with the rest of the world largely unaffected and even seeing growth on a big scale. The shock of the pandemic depression is globally shared, with a “larger proportion of the global community in recession than at any other time since the Great Depression.”  

The depression will cast a long shadow over the future, with the recovery not as robust or rapid as the downturn. The fiscal and monetary stimuluses will mitigate, rather than eliminate, the economic losses, leaving an extended stretch of time before the global economy claws back to where it was at the start of 2020.

The massive economic contraction will result in spike in nonperforming corporate loans, bankruptcies, and sovereign defaults, followed by a financial crisis. The path will be similar to the crisis of 2008, but more severe reflecting the scale and scope of the economic collapse. What is worse is that the crisis will hit the poorer countries and lower-income households harder than others. Slowing the speed of the pandemic requires keeping workers away from work places, and shoppers from the markets. Most workers do not have the nature of work, or ability to work from home.

Some countries are showing signs of a rebound. But, history shows that from the mid-nineteenth century, economic crises took an average of eight years for per capita GDP to return to pre-crisis levels. The rebound is the beginning of a long journey out of a deep hole. Three indicators show that the road to recovery will be a long one.

First, closed borders, lockdowns, reduced global demand, and US-China trade war, have exacerbated the hit on global exports, growth of which had decreased by half between 2008 and 2018. Prices have also declined, especially commodities like oil. This has hit hard countries dependent on exports, tourism, and foreign remittances, and it has come when the economic fundamentals were already weak.

The second relates to unemployment, where recovery will be very slow. With the market economy dismantled, some businesses which have been closed, might never reopen. For many workers, the job loss might be permanent. Others will lose out because of new skills that are required not matching what they have. New graduates could find the going worse. And for those yet to leave the schooling system, quality of education has suffered with social distancing and online classes. Not all countries have the same quality and extent of social safety nets. Apart from problems with the fiscal, thanks to increased doles, the tax base is also shrinking with corporate defaults and reduced incomes and trade. Corrective measures will not be easy as more sovereign downgrades have been the highest since 1980.

The third feature is the highly regressive nature of the crisis, both within countries and across countries. The economic dislocations his those with lower incomes hardest, with reduced employment opportunities, spike in food prices, medical costs, and disruption to supply chains and labour migration patterns. The UN has warned of the worst food crisis in 50 years.

While there could be a rebound, and there are signs of it, this will not deliver a full recovery in the immediate future, even with “enlightened and coordinated macroeconomic policy response.” The rooms for manoeuvre will be limited in most countries barring the larger ones. “…the countercyclical response is going to be smaller in those places hit harder by the shock.” Therefore, the Reinharts conclude that the “fiscal stimulus in the advanced economies is less impressive than the large numbers seem to indicate.”

The central banks have played their part, acting “forcefully and in a hurry,” pumping liquidity into the banking system, lowering reserve requirements, US arranging currency swap agreements with other central banks, preventing temporarily illiquid firms from becoming insolvent.

The Reinharts argue that “Central banks’ foray into territory far outside the norm is a direct result of design flaws in earlier attempts at remediation… After the crisis in 2008, governments did nothing to change the risk and return preferences of investors. Instead, they made it more expensive for the regulated community—that is, commercial banks, especially big ones—to accommodate the demand for lower-quality loans by introducing leverage and quality-of-asset restrictions, stress tests, and so-called living wills. The result of this trend was the rise of shadow banks, a cohort of largely unregulated financial institutions. Central banks are now dealing with new assets and new counterparties because public policy intentionally pushed out the commercial banks that had previously supported illiquid firms and governments. … central bank action has apparently stopped a cumulating deterioration in market functioning with rate cuts, massive injections of liquidity, and asset purchases. Acting that way has been woven into central banks’ DNA since the Fed failed to do so in the 1930s, to tragic effect.”

But, these actions are too small to counter the shock of the pandemic depression. This is perhaps why central bankers from Haruhiko Kuroda of Bank of Japan, to Christine Lagarde of the European Central Bank, and Jerome Powell of the Federal Reserve have been urging their governments to implement additional fiscal stimulus measures. “Their pleas have been met, but incompletely, so there has been a massive decline in global economic activity.”

The deficit-to-GDP ratio in advanced economies is expected to increase from 3.3 percent in 2019 to 16.6 percent in 2020, and in emerging markets, from 4.9 percent to 10.6 percent. Dealing with this debt will hinder rebuilding. Many governments lack the fiscal space for the stimulus required. The G-20 has postponed debt-servicing for 76 of the poorest countries. But, more will be required from the richer countries and lenders in the coming months.

But, there is all likelihood that many countries might turn inward rather than look global. Reverse globalization, which arrived with Trump in 2016, will gather speed. “Stopping the slide in incomes and output is a critical accomplishment, but so, too, will be hastening the recovery. The longer it takes to climb out of the hole this pandemic punched in the global economy, the longer some people will be unnecessarily out of work and the more likely medium- and longer-term growth prospects will be permanently impaired.”

The Reinharts predict that the shadow of this crisis will be long and dark—more so than those of many of the prior ones. What could be the future consequences? “As future income decreases, debt burdens become more onerous. The social consequences are harder to predict. A market economy involves a bargain among its citizens: resources will be put to their most efficient use to make the economic pie as large as possible and to increase the chance that it grows over time. When circumstances change as a result of technological advances or the opening of international trade routes, resources shift, creating winners and losers. As long as the pie is expanding rapidly, the losers can take comfort in the fact that the absolute size of their slice is still growing. For example, real GDP growth of four percent per year, the norm among advanced economies late last century, implies a doubling of output in 18 years.”

As a fallout of the pandemic depression, “…tide of populist nationalism often rises when the economy ebbs, so mistrust among the global community is almost sure to increase. This will speed the decline of multilateralism and may create a vicious cycle by further lowering future economic prospects. That is precisely what happened in between the two world wars, when nationalism and beggar-thy-neighbor policies flourished.”

While there are no one stop solutions, they recommend three: preventing the economic conditions that produced these pressures from worsening, pressing on with fiscal and monetary stimulus, and refraining from mistaking a rebound for a recovery.

Not a very encouraging prognosis. But, a very telling reminder that a great deal of hard work lies ahead, and it is going to be a long way ahead before economies could be brought back to pre-crisis times.

© G Sreekumar 2021

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