In the 14th century, the bubonic plague wiped out a third of Western Europe’s population and countless many lives globally. More recently, the influenza pandemic of 1918 infected a third of the world’s population, killing at least 50 million people. In both cases, there were profound economic and social disruptions but little evidence of longer-term macroeconomic impacts. While the future is unknowable while we wait for vaccines or other treatments, the broad consensus amongst market observers today is that a swift and strong recovery will follow COVID-19 once it is controlled. A key risk to this outlook is complacency in assessing the mechanisms for recovery in what was already a fragile landscape beset by trade and geopolitical tensions.
Not all is equal across countries or within national borders. Despite the strong and often coordinated public policy responses observed over recent weeks, outcomes are very much reliant on fiscal headroom and infrastructure capacity. Emerging markets in particular have little of either and are most exposed to risk aversion and capital outflows. Within advanced economies as well, it is difficult to envisage external debt forbearance not playing a central role for the likes of Italy or Greece. Despite calls from multilateral agencies such as the IMF, resource sharing and the mutualisation of risk does not come naturally to free markets as we saw in the decade following the global financial crisis. During acute phases of market uncertainty, financial deleveraging can be a pernicious race to the bottom even with more robust capital and liquidity buffers in place in the banking sector.
The sudden collapse of economic activity underscores the importance of more targeted policy interventions during the recovery phase. Public spending to support households, businesses and financial markets will in due course need to be accounted for through taxation and other forms of redistribution that are perceived as transparent and fair. Greater wealth and income transfers across generations seem all but inevitable given the asymmetric impact that this crisis will have on lives and livelihoods. Meanwhile, the composition of economic activity across geographic regions will require a proportionate policy response if previous disparities are not to be accentuated. Local authorities in particular will rely on closer coordination with central governments so that the delivery of the essential labour market and health and social care services are both timely and adequately funded.
Given the wide variation of COVID-19’s impact, the challenge for policy makers will be to maintain the flow of credit to the economy to support the solvency of businesses. Not all firms will survive, amplifying job losses. While the near-term appeal of policies such as a universal basic income is understandable, it might be less costly and more effective to expand unemployment insurance and other benefit schemes to target those most affected, including the self-employed. Ultimately, monetary and financial stability will provide the foundation needed to stabilise market sentiment and ease global financial conditions so that longer term scarring to the economy is minimised.
The road to recovery may not be clear in the midst of a crisis, but taxpayers should not be exposed to unnecessary levels of risk either. Supporting zombie firms or dropping money into households that is saved rather than spent will do nothing to enhance productivity. Governments should continue to support capacity in technology, connectivity and research and development while incentivising businesses to rehire through the provision of generous workforce development and worker retraining schemes. Indeed, given the high levels of epidemiological and economic uncertainty that are likely to persist, the climate will not be conducive for a sudden revival in capital investment. Balance sheet repair will soon become a priority in both the public and private sectors as borrowing costs normalise.
Perhaps the greatest risks and opportunities relate to the future of globalization. The populism and trade rhetoric of the past decade may dovetail with issues of public health and national security, thereby reinforcing calls for greater self-reliance. Recent missives from the Trump administration would aggressively restrict immigration into the US, while the trade spat with China is likely only to intensify as the president prepares his re-election campaign. Across the pond, the UK has reiterated its calls to expedite the conclusion of Brexit as a means to enable greater policy latitudes to deal with COVID-19. This is despite the European Union already having relaxed many of its rules to allow member states such capacity.
Protectionism of goods, services and people would hinder global supply chains and exacerbate the inequalities that contemporary societies are desperately seeking to address. Such actions certainly did not alleviate the suffering of the Great Depression in the 1930s but rather amplified the propensity for conflict culminating in the Second World War. A repeat today could tip a global economy beset by low growth and low inflation into another lost decade.
Alternatively, governments may acknowledge that resilience to cross-border shocks ranging from pandemics to climate change require greater compromise and cooperation, not less. The reality is likely to lie somewhere in between – a muddle through that places increasing demands on already stretched fiscal and monetary frameworks.
The need for accountability and transparency of the public purse has never been greater.
