Economic rock bottom is on its way for many countries as the COVID-19 pandemic continues its saunter across the globe, defying rushed attempts to ‘flatten the curve’. When and how fast individual economies will recover in the short term is simply unknown, driven in part by the unknowns surrounding the virus itself.
Expanding our time horizon, we know that robust long-term forecasts more than a year out are nearly as impossible to get right, and when they are right, it’s more of a happy accident than forgone conclusion that prediction was possible. The greatest value of long-term forecasting is more often in the process of identifying the warning signs than the actual prediction.
But what happens when the trends, assumptions, and best information to date you rely on for forecasting are upended by global events? Phenomena that alter the dynamics between economic actors, social norms and promises, and household behavior within and between economies? The COVID-19 pandemic is no doubt such a phenomena and in this article we will look ahead to the potential long lasting effects of the pandemic to answer the question: COVID-19 – Is it a directional change or a velocity shift for global economic development?
Growing Debt Burden: Redefining Economic Potential or Temporary Output Gap?
In response to the COVID-19 pandemic most governments have provided economic stimulus to support financial systems, businesses and households and will emerge from the current recession with substantially greater debt burdens. Stimulus packages vary across countries from a small fraction of GDP to as much as 25 percent of GDP.
- Stimulus packages include additional liquidity for banking systems, lowering taxes, and increasing government expenditures, as well as noticeable reductions of policy rates by central banks.
- In early April, the announced stimulus packages in each of the major developed economies as well as China were close to or in excess of 10 percent of GDP and roughly a dozen countries cut their policy rates by at least 50 percent.
- According to recent research from Wells Fargo, steps taken by the US government to combat the COVID-19 outbreak will likely balloon the US federal budget deficit to about 17 percent. The debt-to-GDP ratio of the US federal government is expected to increase from 79 percent in FY 2019 to 96 percent in FY 2020.1
For decades economists have argued about ‘sustainable’ debt levels. COIVD-19 will bring new fire to this debate and the policy prescriptions for it. Long term, we’ll see major economies adjusting their budgets to eventually return to more or less ‘sustainable’ fiscal balances. Businesses and households will follow suit, saving more and investing less to reduce their debt burdens. What this means in the short-term is that economies will underperform compared to their potential, and the global economy will struggle to rebound, potentially defying estimates from the likes of the IMF that suggest a rebound within reach in 2021.
A slower recovery is not the same, however, as a long-term trajectory shift. There is insufficient evidence that the long-term output growth will be undermined by the current elevated global debt burden. Policy options exist. Roughly 20 years ago Japan implemented a ‘zero interest rate’ policy, a policy repeated by other major economies to manage debt burdens in times of financial crisis – a new era of negative and low interest may very well be the new normal post-COVID as well to cope with new debt burdens.
More Resilient, More Local Supply Chains
Countermeasures to the COVID-19 pandemic have led to the collapse of international trade as borders have closed, demonstrating the fragility of global value chains in a highly interconnected world. For the duration of the global recession, export oriented economies will face reduced external demand for both primary resources and manufacturing products, which is a real, immediate shock to those economies.
The path to economic recovery, however, is likely to go through domestic markets rather than global. By the mid-2000s, the primary drivers behind globalization—we’re talking about reductions in tariffs, reduced transportation costs, and lower interest rates—had been largely exhausted. In addition, reliance on imports of manufactured goods started to undermine developed countries economically and technologically as well as from a military and strategic power perspective, leading governments to resist opening domestic markets further, especially to China and its high tech goods.
The world is in essence being split up again step-by-step into regional and local markets, accelerated by COVID-19 and now threatening a domino effect globally. According to the World Trade Organization (WTO), 80 of the world’s economies have introduced export prohibitions or restrictions as a result of the COVID-19 pandemic, covering everything from medical supplies (e.g. facemasks and shields), pharmaceuticals and medical equipment (e.g. ventilators) to foodstuffs, and nearly 40 percent were justified as “necessary to protect human, animal or plant life or health”.2
- Under certain circumstances, the WTO warns that new COVID-period export restrictions may ultimately move countries to rely on lower supply, higher price goods produced domestically to compensate for unpredictable access to essential goods that would otherwise have been imported.
- Even pre-COVID, the data was leaning local. China—a leading global exporter and the “world’s factory”—had already reduced its export dependency (share of merchandise exports to GDP) by nearly 50 percent between 2008 and 2019.3 The United States is pushing in the same direction as Americans express interest in buying more goods made in America, revising and pull back from multilateral trade accords and escalating trade wars (steel, China, and more).
Unprecedented Rate of Technological Progress Could Accelerate Even Further
The ‘Era of Digital Revolution’ we are living in now brought an unprecedented pace of technological progress compared to the prior four technological waves. What scientists told us was completely impossible would somehow appear as if by magic on the market in less than 5 years. The first self-driving car from Google is but one of hundreds of examples of technology outstripping general expectations.
Paradoxically, a less (economically) globalized world like the one that we see emerging has the power to accelerate technological progress even more and dampen the global economic effects of COVID-like pandemics in the future. Reliance on domestic supply chains in developed countries where workers are paid relatively high wages is impossible without automation of the production processes and stimulation of robotics and other additive technologies.
- With fewer people employed at factories, production too is less susceptible to future COVID-19 like pandemics.
- The COVID-19 pandemic will likely also accelerate innovations in biotech, telemedicine, online learning, and remote work based on the accelerated turnarounds in development and testing during this prolonged, crisis-driven period.
- The face of currency could also change as more people rely on digital financial transactions, stimulating the emergence of centralized digital currencies.
Of course the impact of COVID-19 pandemic is not limited to the above mentioned global development trends. Health systems, the industrial landscape, commodity markets and prices, geopolitics, world conflicts, poverty and many other aspects of global economics, social welfare, and development will be affected by the COVID-19 pandemic.
What struck us as we researched this article is that for all three of the trends we featured, the COVID-19 pandemic is not changing the path of global development but accelerating trends that were simply under the radar prior to the pandemic. The world’s economies were already accumulating debt and sustaining historically low (sometimes extremely low) interest rates. Globalization had stumbled on natural obstacles such as national security and fewer and fewer benefits in favor of deeper global trade expansion. Technology has advanced at breathtaking rates.
Out of the three factors that guide long-term economic growth potential—technology, labor, and capital—at least two will not be affected: COVID-19 is highly unlikely to paralyze technological progress and, due to epidemic related characteristics, the effect on global population trends will be invisible. How fast the global economy turns back to its long-term path after the end of the pandemic will instead depend largely on the efficiency of the financial sector in turning rising debts into non-financial assets. For that reason, we’ll be monitoring the data universe for leading indicators on the success and failures as well as the sustainability of stimulus responses globally.
- H. Bryson, M. Pugliese, H. Mathews. Fiscal Fallout from the COVID-19 Pandemic: Part I. Wells Fargo Securities. April 20, 2020. Link
- Export prohibitions and restrictions. WTO Information Note. April 23, 2020. Link
- Lardy, T. Huang. Weak exports will not stall China’s manufacturing recovery. PIIE. April 15, 2020. Link