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Opinions of Friday, 3 July 2020


Coronavirus: More severe economic fallout than anticipated (2)

Christine Lagarde, European Central Bank Head Christine Lagarde, European Central Bank Head

Likely Reversal of Progress on Poverty Reduction

These projections imply a particularly acute negative impact of the pandemic on low-income households worldwide that could significantly raise inequality. The fraction of the world’s population living in extreme poverty—that is, on less than $1.90 a day—had fallen below 10 percent in recent years (from more than 35 percent in 1990).

This progress is imperiled by the COVID-19 crisis, with more than 90 percent of emerging market and developing economies projected to register negative per capita income growth in 2020.

In countries with high shares of informal employment, lockdowns have led to joblessness and abrupt income losses for many of those workers (often where migrants work far from home, separated from support networks).

Moreover, with widespread school closures in about 150 countries as of the end of May, the United Nations Educational, Scientific and Cultural Organization estimates that close to 1.2 billion schoolchildren (about 70 percent of the global total) have been affected worldwide.

This will result in significant loss of learning, with disproportionately negative effects on earnings prospects for children in low-income countries.

Risks to the Outlook

Fundamental uncertainty around the evolution of the pandemic is a key factor shaping the economic outlook and hinders a characterization of the balance of risks.

The downturn could be less severe than forecast if economic normalization proceeds faster than currently expected in areas that have reopened—for example in China, where the recovery in investment and services through May was stronger than anticipated.

Medical breakthroughs with therapeutics and changes in social distancing behavior might allow health care systems to cope better without requiring extended, stringent lockdowns. Vaccine trials are also proceeding at a rapid pace.

Development of a safe, effective vaccine would lift sentiment and could improve growth outcomes in 2021, even if vaccine production is not scaled up fast enough to deliver herd immunity by the end of 2021.

More generally, changes in production, distribution, and payment systems during the pandemic could actually spur productivity gains—ranging from new techniques in medicine to, more broadly, accelerated digitalization or the switch from fossil fuels to renewables.

Downside risks, however, remain significant. Outbreaks could recur in places that appear to have gone past peak infection, requiring the re-imposition of at least some containment measures.

A more prolonged decline in activity could lead to further scarring, including from wider firm closures, as surviving firms hesitate to hire jobseekers after extended unemployment spells, and as unemployed workers leave the labor force entirely.

Financial conditions may again tighten as in January–March, exposing vulnerabilities among borrowers. This could tip some economies into debt crises and slow activity further.

More generally, cross-border spillovers from weaker external demand and tighter financial conditions could further magnify the impact of country- or region-specific shocks on global growth.

Moreover, the sizable policy response following the initial sudden stop in activity may end up being prematurely withdrawn or improperly targeted due to design and implementation challenges, leading to misallocation and the dissolution of productive economic relationships.j

Beyond pandemic-related downside risks, escalating tensions between the United States and China on multiple fronts, frayed relationships among the Organization of the Petroleum Exporting Countries (OPEC)+ coalition of oil producers, and widespread social unrest pose additional challenges to the global economy.

Moreover, against a backdrop of low inflation and high debt (particularly in advanced economies), protracted weak aggregate demand could lead to further disinflation and debt service difficulties that, in turn, weigh further on activity.

Policy Priorities

With the relentless spread of the pandemic, prospects of long-lasting negative consequences for livelihoods, job security, and inequality have grown more daunting. Further effective policy actions can help slow the deterioration of those prospects and set the stage for a speedier recovery that benefits all in society across the income spectrum and skills distribution.

At the same time, considering the substantial uncertainty regarding the pandemic and its implications for different sectors, the policy response will have to adapt as the situation evolves to maximize its effectiveness—for instance, shifting from saving firms to facilitating resource reallocation across sectors.

As discussed in the April 2020 WEO, these policy objectives are shared across emerging market and developing economies as well as advanced economies, but the former group is relatively more constrained by lower health care capacity, larger informal sectors, and tighter borrowing constraints.

Moreover, some emerging market and developing economies entered this crisis with limited policy space. External support and strong multilateral cooperation are therefore essential to help these financially constrained countries combat the crisis. This is particularly the case for low-income countries.

Many of these have high debt, and some are already in a precarious security situation, with scarce food and medicine. Hence, their ability to deploy the policy response needed to prevent a devastating human toll and long-lasting impacts on livelihoods depends critically on debt relief, grants, and concessional financing from the international community. Island economies that rely heavily on tourism and economies that are driven by oil exports are also likely to face long-lasting challenges.

Resources for Health Care

The pandemic continues to test health care capacity in many countries, accelerating in emerging market and developing economies. Other countries that have passed peaks in infections remain at risk of renewed surges. All countries therefore need to ensure that their health care systems are adequately resourced.

This requires additional spending as needed in various areas, including virus and antibody testing; training and hiring contact tracers; acquiring personal protective equipment; and health care infrastructure spending for emergency rooms, intensive care units, and isolation wards.

Multilateral cooperation to support health care systems.

The international community needs to vastly step up efforts to support national initiatives, including completing the removal of trade restrictions on essential medical supplies; sharing information on the pandemic widely and transparently; providing financial assistance and expertise to countries with limited health care capacity, including via support for international organizations; and channeling funding to scale up vaccine production facilities as trials advance so that adequate, affordable doses are quickly available to all countries.

Contain the Economic Fallout, Facilitate Recovery

Confronted with a highly transmissible virus and susceptible populations, countries have restricted mobility to curb its spread and protect lives. In the resulting deep economic downturn, the broad economic policy objectives remain similar to those discussed in the April 2020 WEO, with a continued emphasis on sizable, well-targeted measures that protect the vulnerable.

As economies reopen, the focus there should gradually move from protecting jobs and shielding firms to facilitating recovery and removing obstacles to worker reallocation. Elevated debt levels, nonetheless, could constrain the scope of further fiscal support—and will pose an important medium-term challenge for many countries.

To ensure that economies are well prepared to counter further shocks, policymakers should consider strengthening mechanisms for automatic, timely, and temporary support in downturns.

As analyzed in the April 2020 WEO, rules-based fiscal stimulus measures that respond to deteriorating macroeconomic conditions—such as temporary targeted cash transfers to liquidity-constrained, low-income households that kick in when the unemployment rate or jobless claims rise above a certain threshold—can be highly effective in dampening downturns.

Economies where the pandemic is accelerating.

In countries where lockdowns are required to slow transmission, the emphasis should be on containing the health shock and minimizing damage to the economy so that activity can normalize more quickly once the restrictions are lifted.

The objective is twofold: cushioning income losses for people to the extent possible while enabling the shift of resources away from contact-intensive sectors that will likely be persistently smaller after the pandemic.

Targeted measures, such as temporary tax breaks for affected people and firms, wage subsidies for furloughed workers, cash transfers, and paid sick and family leave are good common practices for cushioning income losses.

The specific mix of targeted support should be tailored to country circumstances with due consideration for those who may not be protected by the formal safety net (as discussed below).

Temporary credit guarantees, particularly for small and medium-sized enterprises, and loan restructuring can help preserve employment relationships likely to remain viable after the pandemic fades. In tandem, spending on retraining, where feasible, should be increased so that workers are better equipped to seek employment in other sectors as needed.

Broader social safety nets should be enhanced, including to expand eligibility criteria for unemployment protection and provide better coverage of self-employed and informal workers.

Central bank liquidity provision and targeted relending facilities for funding-affected firms can help ensure that credit provision continues, while policy rate cuts and asset purchases can limit the rise in borrowing costs.

Public infrastructure investment or across-the-board tax cuts may be less effective in stimulating demand when large parts of the economy are shut down. Nonetheless, where financing constraints permit, such measures can play an important role in supporting confidence and limiting bankruptcies.

Economies where reopening is underway.

Many countries have begun scaling back stringent lockdowns. With reopening, policy focus must also shift toward facilitating recovery. This requires progressively unwinding targeted support as the recovery gets underway, incentivizing the reallocation of workers and resources where needed, and providing stimulus.

The exit from targeted support—such as wage subsidies for furloughed workers, cash transfers, enhanced elibility criteria for unemployment insurance, credit guarantees for firms, and moratoria on debt service—should proceed gradually to avoid precipitating sudden income losses and bankruptcies just as the economy is beginning to regain its footing.

The sequence in which the targeted measures are unwound should take into account the structure of employment—for instance, the share of self-employed, the distribution of firms across sectors experiencing different rates of recovery, and the degree of informality in the economy.

Where fiscal space permits, as targeted fiscal support is unwound, it can be replaced with public investment to accelerate the recovery and expanded social safety net spending to protect the most vulnerable.

The former can support the transition to a low-carbon economy and mitigation strategies.

The latter will be particularly important given that the pandemic has taken a significant toll on lower-skilled workers (who may have a harder time securing reemployment than higher-skilled workers) and lower-income households more generally (who may not have adequate resources to purchase health care and essentials).

At the same time, hiring subsidies and spending on worker training will need to increase to facilitate reallocation toward sectors with growing demand and away from those likely to emerge persistently smaller from the pandemic.

Policymakers should also address factors that can impede this reallocation, including barriers to entry that favor incumbents at the expense of potential entrants and labor market rigidities that deter firms from hiring.

Easing reallocation will also involve actions to repair balance sheets and address debt overhangs—factors that have slowed past recoveries from deep recessions. This will require mechanisms for restructuring and disposing of distressed debt.

Such steps to reduce persistent resource misallocation and productivity losses can further enhance the effectiveness of broader stimulus to lift aggregate demand and boost employment.