Planning for Crisis Resilience
Large international disparities in the economic cost of the COVID-19 crisis should surprise no one. The question is what can be done to ensure that economies are able to bounce back as quickly as possible.
CAMBRIDGE – When you throw a tennis ball to the ground, it bounces back up. But if you throw a wine glass, it shatters. Many countries’ economies are in free fall. Will they bounce back or shatter? What can be done to assure a strong recovery?
The economic consequences of the COVID-19 pandemic may not be obvious, as ongoing research with Sebastián Bustos on previous crises suggests. In the 2008 global financial crisis, among the least affected countries were financial centers such as the United States and Switzerland, while the most affected were Greece, the Baltic countries, Italy, Ireland, Spain and Portugal, where forgone output was 10-100 times larger.
Likewise, following the collapse of the Soviet Union, Central Asian Tajikistan and European Moldova and Ukraine lost two-thirds of their GDP at the trough, whereas Tajikistan’s neighbor, Uzbekistan, as well as Estonia and Belarus (adjacent to Ukraine) lost less than one-third. During the Latin American debt crisis of the early 1980s, the worst-affected countries were low-income Bolivia but also upper middle-income Uruguay and Chile, while the least affected were Mexico (where the crisis began), Panama, Honduras, and Paraguay. And following the Arab Spring of 2011, GDP in Tunisia (where it all started) fell by less than 2% at the trough while Egypt did not even experience a recession. By contrast, Libya, Syria, and Yemen suffered major collapses.
One way to think through previous crises’ seemingly disparate consequences is by considering three sources of variation: the magnitude of the economic shock, the resilience with which the economy responds, and the political consequences of the shock.
The hardest-hit countries in the 2008 crisis and the Latin American debt crisis were those running large current-account deficits that they could no longer finance, owing to the collapse in capital flows. Resilience was related to the ability to substitute imports and increase exports, thereby closing the external deficit in a less contractionary manner.
Countries unable to do this, like Greece or Bolivia, suffered a catastrophic collapse in output and tax revenues that morphed into a public-debt crisis. In Chile, the external debt had been contracted by a private banking system that quickly plunged into crisis, causing a deep output collapse. In the Arab Spring, the major difference was between countries that could manage a relatively coherent political transition and those that suffered state collapse and war.
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The collapse of the Soviet Union ended federal transfers to the republics, such as Tajikistan, and Soviet-bloc countries like Cuba, explaining the depth of their recessions. But the collapse also created a plethora of new borders and currencies, which destroyed existing value chains and severely disrupted the more integrated European republics like Moldova and Ukraine.
So, what kind of shock is COVID-19, and what will determine who will suffer more and who less?
The pandemic’s economic impact is multifaceted. The lockdowns were essentially a labor-supply shock (people could not go to work), and a demand shock affecting schools, universities, tourism, entertainment, restaurants and bars, and any activity requiring physical interaction. The inability of households and firms to make rent, service loans, meet payroll, and pay taxes triggered a cascade of business closures, job losses, furloughs, bankruptcies, and ballooning fiscal deficits.
Countries differ dramatically in the epidemiological effectiveness of their public-health measures. Draconian lockdowns in Latin America and South Africa have been less effective in general than in Europe. Several factors may come into play: the structure, size, and space of households; features of the informal sector, transportation, and retail; and social practices. Some countries, such as Israel, were effective at dealing with the initial outbreak, only to fall prey to a larger second peak.
Two other dynamics hit countries differently: the decline in foreign earnings (owing to lower exports, tourism, and remittances) and access to international finance.
Countries differ not only in the size of these shocks but also in their ability to cope with them. Some countries have mobilized unprecedented fiscal resources to shore up households, firms, and banks. Others have had no such fiscal space. Some countries have floating exchange rates and credible central banks, enabling them to conduct an independent monetary policy, lower interest rates, and engage in quantitative easing. Others have pegged exchange rates or are dollarized, severely limiting their options.
Given these differences, it should not surprise us to find large disparities in the economic cost of the crisis. The question is what can be done to ensure that economies bounce back as quickly as possible.
To shorten the period in which economic activity will be restricted by lockdowns and social distancing, countries need to be acting now to secure access to vaccines and to develop their vaccination strategies. Moreover, a multilateral agreement to support the mutual recognition of health passports would enable international travel to recover more quickly.
Furthermore, countries urgently need to invest in their capacity to learn from their own data about how to increase the effectiveness of their social-distancing policies while minimizing the economic losses. They also need to provide poor families with Internet access.
As for fiscal policy, countries need to plan for further massive support to the economy in 2021, pre-funding their future financing needs now in preparation for what promises to be a complicated relationship with the virus and growing financial vulnerabilities for consumers, firms, banks, and currency markets.
Governments should be considering a post-vaccination economic recovery package as well, and financial institutions should be creating private equity funds in order to invest in promising companies with crisis-impaired balance sheets. Finally, governments need to make commitments now about their medium-term tax and spending policies to assure capital markets and international financial institutions of their ability to service the increased debt they will need to manage the crisis.
To achieve all of this, politics needs to play a constructive role. Unless effective leadership bounces back, little else will.