The economic consequences of the coronacrisis

MA student Vincenzo D’Egidio and Professor of Pluralist Development Economics, Irene van Staveren discuss the global economic consequences of the corona pandemic.

Vincenzo (V) - I want to analyse in detail the impact of the coronacrisis. In the first instance it’s a health crisis, but it’s also a social and economic one. I want to outline and define the connection between these and consider the differences between them.

Irene (I) - Which countries will you analyse? Will you compare Italy with developing countries for example?

V – I wasn’t planning on studying a particular country but to run my own survey, collecting my own data. I was planning to look at the global trend and at how developing countries are more or less affected by these crises. For example, in India the healthcare system is not able to provide enough coverage and insurance for the population. This will become a really big issue. I am also thinking about places where the healthcare system is well developed but in such a way that it doesn’t provide enough coverage for the population: countries which don’t have a public system – everyone has to pay for their healthcare yet not many people can afford these expenses.

I – It’s a very urgent and timely and important topic. The difficulty is that the data are emerging real time so you can’t just check World Bank or World Development data. That’s a challenge. There are a couple of agencies, in the Netherlands and elsewhere, which are funding researchers who are collecting real time data now so I hope you’ll be able to find some statistics.

V – Have you been working on this coronacrisis outbreak or are you planning to do so?

I – I’m a member of a Dutch thinktank called the Sustainable Finance Lab (SFL). This consists of about 15 professors, mostly of economics but also some professors of sustainability. We set up the Lab two years after the previous crisis of 2008 because the banks seemed to have played a big role in that crisis. We wanted to help the financial sector become more stable so that it wouldn’t happen again; so that the taxpayer wouldn’t have to bail out the big banks again. We also wanted to try to get the financial sector in the Netherlands to become more sustainable and to put its money less in all kinds of fancy financial assets like derivatives and put it more in a transition into a green economy.

So although the SFL was set up as a result of the previous crisis, many things in the financial sector are still not as good as we would like them to be. Banks still have low buffers, they’re not resilient enough, they don’t fund the real economy sufficiently and so on.

In the context of the current coronacrisis, members of the SFL, including myself, are looking at the impact of this crisis on the economy and the role of the financial sector, Because the financial sector can hopefully play a better role this time. The banks were part of the problem last time, maybe they can be part of the solution this time. I don’t know: it’s not as if the buffers have grown so much that the banks are now very resilient. I think that if the crisis goes on much longer, we will see problems in the banks as well. But at the moment they can grant companies and households who are in financial trouble postponements to paybacks.

As a member of the SFL I’m concerned about the enormous economic consequences of the coronacrisis, so I’ve been writing a couple of articles and giving interviews on it and its effects on the economy. The Ministry of Foreign Affairs asked several people, myself included, to write a short piece on developing countries. So I’m interested in the economic impact from the corona crisis in the Netherlands but also in developing countries.

V - The problems caused by the corona virus run deep: the coronavirus has deeply changed the landscape of the affected countries. We cannot assume that institutions, local authorities, private workers and so on will see a (post crisis) phase 2 as a new start. The population will struggle to cope with the aftermath of the crisis (i.e. fear of a renewed increase in the contagion curve, new consumption/saving profiles, etc).

I - I think people starting to talk about the economy and life before and after corona is a big shift. And I think it’s a shift in many areas of life, in health, in social life, in economic life and in politics. You can see the important role of the government now, both in shutting down sectors completely as well as in the huge financial support packages, that’s new.

V - How do you see the actions by the EU Commission, such as intervention by the European Central Bank (ECB)?

I - We discussed this in the Sustainable Finance Lab and I have also written a bit about it. I think it’s good that there are finally decisions on huge support packages, specifically for the southern European countries. I’m happy that in the EU there is now at least a commitment to provide financial support. My concern is that it will only increase the level of debt of the already highly indebted countries. Italy has a huge level of public debt. Greece also has a huge debt level and we haven’t heard much about Greece yet. The good thing about Greece is that it reacted very quickly to the coronacrisis: because it started very quickly with the lockdown, it doesn’t have many casualties. But the question is, will tourists go there this summer? 20% of the Greek economy relies on tourism and it doesn’t have a real industrial sector. I think that southern European countries don’t need loans, they need grants. Furthermore, I think that monitoring financing should benefit these countries. I’m referring to the purchasing policy of the ECB in terms of corona bonds. I am very much in favour of corona bonds as a way to avoid the debt problem becoming too great for southern European countries.

V - Corona bonds have a debt service, right?

I - Yes, but corona bonds are Eurobonds so the risk is spread, meaning that countries in the south can borrow at a low interest rate. The second step would be for the ECB to buy some bonds from the southern countries. We could also think about the European Investment Bank doing that.

...a complete and deep recovery of the economic system after the lockdown will only be possible with harmonization of different policy mixes.

V - But may this not lead to a liquidity trap situation where expansionary policies are inefficient in a context where interest rates are already close to zero?

I - Yes, but that’s the new normal. The interest rate of around zero has been around for a couple of years now and will remain at zero for a couple more years. That’s the price we have to pay for keeping debts bearable.

V - People are talking about helicopter money (printing of extra money) with the government investing a lot of money as financial assistance to small and medium companies.

I - I think it is the right time for helicopter money, partly because the interest rate is so low, so the risk of inflation is very limited. And even if inflation went up to say 3 or 4%, so what?
So yes, I think we need helicopter money but at the European level, through the ECB. And if we make the link to developing countries, what is interesting is that there’s also a possibility for helicopter money through the International Monetary Fund (IMF). Not directly with dollars, but indirectly because the IMF has created an international currency; special drawing rights (SDRs). These special drawing rights are distributed from the IMF to countries to use as a reserve, but they’re convertible into money. At the moment, every special drawing right can be converted to US$1.35. Every country in the word has SDRs on the balance sheet of their central banks. But what if we exchange them at the IMF for dollars? Or with rich countries for hard currency like euros and dollars? That is a way of letting helicopter money work for low income countries: it’s not a loan, they never borrowed the money, it’s just on the central bank’s balance as a reserve. So my suggestion is that the IMF increases its SDRs to the world. It did so in 2009, after the previous crisis. That would enable developing countries, and other countries that need it, to exchange their drawing rights for dollars or euros with other countries or the IMF to stimulate their economy. And I suggest that the countries that don’t need it, like the Netherlands, donate part of their SDRs to countries that do. This would be development aid in the form of a grant, not a loan.

V – So a kind of redirection of investment?

 I - Yes, the money can then be invested back into the economy. Currently, SDRs are a kind of reserve, not really an investment fund. They are simply reserves that a country can claim from the IMF; reserves that the IMF created out of thin air just like a financial bank creates money. The IMF has distributed these around the world in proportion to the size of the economy and the country’s contribution to the IMF. But in theory these reserves are convertible back into currency, it’s just that countries have never done so before.

V - Sure, but this also involves coordination, also between national governments at the international level. There is agreement across studies that a complete and deep recovery of the economic system after the lockdown will only be possible with harmonization of different policy mixes. Individual countries will need to agree on an inclusive recovery project shared at the international level. I don’t think we are witnessing such a coordination at the moment with different governments taking different decisions, each tackling the coronavirus from a different angle. I don’t know to what extent we have a shared vision of this new situation.

I - Yes, true and obviously interests aren’t exactly the same worldwide. But at the same time, many countries realise they can’t solve this alone and if some countries fall into a very deep recession then this is likely to happen in other countries as well.

V - Are the low oil prices related to this?

I - Yes, I think we should take this crisis as an opportunity to prevent the next crisis, and the next crisis is the climate crisis. We don’t need to save the oil companies; we should let them go if they don’t survive.

V - In a recent press conference, Trump said something about how to tackle the coronavirus using humanitarian measures. This is a perfect example of how countries see things differently. Some governments take the crisis seriously whilst some try to downsize it. I’m trying to understand how a country like the US might downsize the impact on welfare and the social order

I - The interesting thing is that not everybody in the US supports Trump. Furthermore, formally central banks are supposed to be independent of governments and you see that the Federal Reserve in the US has issued bonds to several developing countries to provide them with extra liquidity, and thus stability, to fight the crisis. President Trump may say one thing, but the Federal Reserve is much more practical and well understands that it needs to support big developing countries like Brazil and Mexico.

V - We can assume that the economy will recover soon from the coronacrisis. This crisis is different from the global recession crisis of 2007-2008. While that crisis was set off by a real estate bubble that was ‘endogenous’ to the economic system, the corona outbreak works as ‘manna from heaven’. It is an exogenous shock which is not the result of financial speculation and lack of regulation. As we know from the past, when the crisis is exogenous (i.e. pandemic, natural disaster), recovery is faster.

The coronacrisis has shown the vulnerability of .... massive specialization.

I - I fully agree that the financial crisis was endogenous and that there was something structurally wrong in the economy which built up a bubble. The coronacrisis is an exogenous crisis, it is a shock to the system and that implies that we can recover faster. But there is one big condition for this: the underlying problem for the financial crisis was huge private debt. Since 2008, the level of private debt in the world has increased. So if the solution at the macroeconomic level to the current recession is more debt, I’m not sure whether we will be able to recover so quickly. And that is precisely why I make a plea for corona bonds, for helicopter money in Europe, and for helicopter money for low-income countries through an increase in SDRs and the exchange of SDRs for hard currency. We have to be much more creative with financial support that does not increase the level of debt.

V - More money may be the solution for small and medium economies. We also have to consider new ways to recover from this lockdown: we have never seen anything like this before and people are unsure of how to deal with it. I don’t think this coronacrisis can be seen as a second wave crisis in which there are generally transmission channels causing the crisis to spread globally. I think it’s a first wave crisis, i.e. there are no external transmission channels. I don’t really know how to deal with the development issue in such a context.

I - I think if we look at the world economy as a whole, we see that the majority of world trade is dominated by multinational companies, by intercompany trade. That is because of huge specialization in low cost production along very long value chains with many of these chains anchored in China. The coronacrisis has shown us the vulnerability of such huge specialization: in the global north we become too dependent on just a few value chains for key products like face masks, ventilation machines or medication (most of the world’s factories for paracetamol and aspirin are in India and China). And at their end, the economies of India and China have become too dependent for their employment from the same value chains. So this crisis shows the huge vulnerability both of the global north and the global south. This calls for a systematic change to the world economy away from even more globalization. One way in which we can increase stability and build more resilience is by moving to more regionally organized economies. So shorter supply chains: supply chains within Asia and supply chains within Europe; of course with some international trade but less dependency on a single, long value chain.

V - Maybe that is the best concrete idea in this case though I don’t know whether the whole global economy will be able to implement it. Or whether countries will be willing to do so.

I - Well I think it should happen bottom-up rather than top down, but governments are realising that we should not become too dependent. There’s a trade-off between the efficiency of a fully globalized world with very strong specialization on the one hand and resilience on the other hand. At a micro level we understand this, when we look at investment portfolios. If you’re an investor you don’t invest everything in one fund, you spread your risk. So I think the message from this crisis is that we should apply the same principles and same logic at a global level, so spreading more risk means building more resilience in the system by having more value chains at local and regional levels and less at the global level. We now realise that if Italy or the Netherlands had been able to manufacture their own face masks they would have been less vulnerable. Because now, in the Ministries of Health in Rome, in the Hague, in Paris, there were some public servants working 24/7 trying to source face masks, for example. They’re competing with each other and that is completely inefficient. The interesting thing is that organizing global production chains is the most efficient way we can imagine but that only works in normal times; as soon as there’s a shock it’s completely inefficient.

V - Yes, I see your point. What if the answer is a Sovereign Wealth Fund, a state-owned investment fund? I’m thinking about the example of Norway, with its fund which diversifies risk across different countries and different activities from different sectors.

I - Yes, I fully agree with a Sovereign Wealth Fund like Norway has. When you check the information about this, you will find that some developing countries are also building Sovereign Wealth Funds, partly to build resilience in times of crisis and become less dependent of IMF support programmes. I think such funds would be wise for every country. That’s something that can be done at the national level, it doesn’t need international coordination. And I think it’s wise to do that in good times, to build it up for bad times.