by Linda Yueh, Adjunct Professor of Economics, London Business School
With the rollout of vaccines for Covid-19 last week, the control of the pandemic has begun. The dramatic speed of the development of the vaccines will need to be matched by production and distribution. AstraZeneca has announced that its vaccine developed with the University of Oxford will make two billion doses which will help developing countries. It will take a considerable amount of time until mass vaccinations have occurred everywhere in the world, but governments are now in a better position to plan for the economic recovery.
There will be need for government spending to reduce the risk of permanent damage to the economy from the shock of this global pandemic, which has caused contractions in GDP that are unparalleled in modern history for most economies.
For developed and emerging economies, the International Monetary Fund (IMF) estimates that national output will contract by nearly 6% in 2020, except for China which is forecast to grow. But the speed of recovery is vastly different. For developed economies, GDP is forecast to be a sizeable -4.7% before the pre-pandemic level in 2019. But for emerging economies, excluding China, the loss in output will be a staggering -8.1%.
Central bank policies are pointing to a prolonged recovery as well. The Federal Reserve has signalled that it will keep interest rates at rock bottom until at least the end of 2023. The European Central Bank has extended its pandemic emergency purchase programme until March 2022 while reinvesting its proceeds, i.e., continuing to inject cash, until at least the end of 2023. Both central banks are indicating they are supporting the economy with loose monetary policy for the next three years. It’s a reflection of the scale of economic damage from the pandemic.
Most countries will also need fiscal policies that boost growth to prevent the loss in output from becoming permanent. Some economies are fiscally constrained so they will have limited ability to borrow to spend, which captures some of the differences between the recovery trajectories between advanced economies and emerging economies. While developed economies face record low borrowing costs, a number of developing economies are in need of debt relief and have less capacity to use fiscal policy which will hamper their recoveries.
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In terms of the recovery, the spending should be tailored to jobs. To prevent hysteresis, which is when an unemployment shock lowers growth potential, government spending will need to support jobs and try to prevent discouraged workers which in turn lowers the labour force participation in the economy. The extension of various furlough schemes in Europe into the next year or so as well as the new US stimulus package that is being debated in Congress are both aimed at this issue.
Keeping viable businesses, which are also employers, is another important aspect. For instance, the UK is planning to create a permanent new state-backed loan scheme for SMEs starting in January to replace the Covid-19 programme, which at £65 billion was a sizeable part of the government support.
For advanced economies, the recovery spending can also be designed to support longer-term growth aims (e.g., green growth) and address long-standing challenges (e.g., low productivity). The IMF has changed its emphasis during Covid-19 to encourage countries which can afford to do so to borrow to invest, shifting the emphasis from fiscal discipline to promoting economic growth that can take advantage of record low interest rates.
In their latest World Economic Outlook, the IMF estimated that during periods of high uncertainty such as a global pandemic, 1% of GDP spent on public infrastructure will generate 2.7% in GDP growth and raise employment by 1.2% after two years as well as boost private investment. That translates into between two to eight jobs for each million dollar invested in traditional infrastructure. But, if it is on green infrastructure, such as green electricity or R&D, there would be a bigger impact of five to 14 jobs created by every $1 million invested by the state. The lower capital stock and higher technological component of green investments could generate a larger effect than traditional infrastructure. But there is variation there as well. For instance, digital infrastructure could provide better access and faster broadband that supports remote working and greater e-commerce. Better transport links would help with hybrid working and online deliveries.
In short, creating jobs and boosting greener growth would focus the extraordinary amounts of government spending on both near-term needs and longer-term aims.
Additionally, if governments were to distinguish between current and capital spending, then bond investors can assess whether there will be a longer-term growth impact from the latter spending. Raising the growth rate of the economy relative to the increase in debt would help with the debt-to-GDP ratio typically used in debt sustainability analysis. It won’t be the final word on public finances, but the countries which have spent strategically may be assessed more favourably by creditors.
At the end of 2020, even though the upcoming winter months will be challenging, due to the speed of vaccine development, it is possible to look ahead and start planning more rigorously for the recovery phase.
Linda Yueh is Adjunct Professor of Economics at London Business School and the author of The Great Economists: How Their Ideas Can Help Us Today.
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