Trade wars, populism, and geopolitics. The world is quickly becoming more fraught as complex forces threaten to disrupt and reshape the global economy in profound ways. In this context, the Lowy Institute launched the Global Economic Futures project aimed at better understanding this rapidly changing global economic landscape, where it might take us, and the key choices to be made.
The project examines the future shape of the global economy especially given rising tensions between the world’s two largest economies – the United States and China – and the possible implications for, and changing roles of, major regional economies, including Australia, India, Indonesia and others.
Everyone – including economists themselves – jokes about economic forecasting failures. But the intrinsic difficulties are compounded for the international economic agencies, especially the International Monetary Fund and the Organisation for Economic Co-operation and Development.
Their mistakes are high-profile, as their conjectures are in the headlines and are made on a regular schedule. Unlike private forecasters, they don’t have the opportunity to “forecast early, forecast often”, continually revising to overwrite impending bloopers.
On top of that, they are severely handicapped in their ability to have an agile reaction to unfolding unexpected events. In the “forecasting rounds” that precede the compilation of their numbers, there is extensive consultation with the so-called stakeholders – the representatives of the countries whose performance is being forecast. “Consultation” may not be quite the right word: it’s more an arm-wrestle to get some consensus around the best technical forecast, and the forecast that suits the client government’s current public narrative.
The best arm-waving word to describe the impact on the economy might be “decimate” – in its original meaning of reducing by 10%.
In the feeble recovery after the 2008 crisis, the IMF came under sustained criticism for always being too optimistic about growth prospects. True, they did make technical mistakes, in particular underestimating the depressing effect of the budget austerity of this period. But this was greatly exacerbated by the pressure from member countries to mimic the domestic narrative, helping confidence by staying positive, even optimistic.
The Covid-19 crisis presents a huge problem. At this moment, it looks like it will be necessary to take draconian containment measures to avoid the sort of triage disaster that Italy is experiencing. Yet these sorts of drastic measures will be hugely damaging for the economy. Worse still, if the measures succeed in “flattening the curve” of the epidemic, they will spread the problem out over a longer period, so it’s not just a quarter or two that will be badly affected.
The best arm-waving word to describe the impact on the economy might be “decimate” – in its original meaning of reducing by 10%. Using this round number as in indication of the uncertainty, Australian unemployment could easily exceed 10%, and a fall in GDP of 10% in 2020 is by no means out of the question. But what international agency, sensitive to the views of its membership, would want to print figures like that, when the domestic authorities don’t want to startle the horses and have delayed their own budget process until October because everything is too uncertain?
The IMF made its most recent forecast in January, when their forecasters thought that the world would grow at 3.3%. For the moment, they are sticking to verbal descriptions for the prospects – “a recession at least as bad as during the financial crisis or worse” – when the Fund recorded minus 0.6% growth for the world as a whole in 2009, with minus 3.2% for the advanced economies, and minus 0.6% for the emerging economies. In 2009, China’s 8.7% growth countered weakness elsewhere, but that won’t be repeated in 2020. Let’s see how bold the Fund will be with its forecasts at the April meeting.
Meanwhile, the OECD published interim forecast figures early this month, but they would have been finalised some weeks earlier, in consultation with individual country authorities. Just weeks after publication, these numbers are already looking hopelessly optimistic. The OECD’s chief economist avoided saying very much at all about the forecasts in a recent Financial Times article. The OECD revised down its November projection for world growth in 2020 from an “already low” 3% to 2.4%, with a “downside risk” estimate of 1.5%. China dominates their story, which might be an indicator of how far they are behind current events. The impending revisions can only go one way – down.
For all the drama of collapsing output, demand, and jobs in Australia and many economies around the globe, we should expect that output in most countries will begin to recover once new coronavirus infections peak and head down. It will not be soon, but it will happen.
This is, after all, a deliberate economic recession, one created and encouraged by governments to slow the spread of the virus. There is no reason to expect any extensive destruction of the physical capital on which resumed output growth will depend, and no reason to expect workers to lose skills and knowledge.
For that matter there is no reason to expect any big change in what we buy, what we produce, what kind of work we do, or in global trade and investment, compared to the patterns a few months ago. China, Korea, Taiwan, Singapore and Japan are already heading back to work. Bar a major financial disruption – certainly a possibility, but one central banks are alert to control – much of the rest of the world will also be back at work before the end of the year.
Yet for all the likely similarities, it is also apparent that we will be in a somewhat different world.
One difference will be a big increase in debt. Coming out of this slump the level of output will be down and government debt vastly up. On numbers from the Organization for Economic Cooperation and Development, gross government debt was 136% of US GDP in 2018, and 66% of Australian GDP. We should expect that in a year or so it will be well over 150% of US GDP, and 80% of Australian GDP. Australia’s government debt to GDP will be similar to Germany’s, while the US will be similar to France, and Italy. For a few years these ratios will probably continue to increase.
At the same time households are to be likely adding to debt and running down savings. Borrowers who need it may be able to get mortgages repayments postponed, but the amounts will be added to their debt. Other families will have to borrow on their houses or run down offset balances. All up we should expect to see Australian household debt, already 120% of GDP, creep up. In this respect Australia is an outlier, mainly because of our preference for buying as opposed to renting homes. Even so, most advanced economies should expect to see a big rise in net household debt as consumers try to sustain their spending despite falling income.
In this crisis the rest of the world owes nothing to the leadership of either superpower.
Like households, many businesses will have to seek a moratorium on debt servicing. This will increase their debt coming out of the downturn. Some debt will be written off as companies go broke, but even so business is likely to come out of the pandemic more indebted than it went in.
The increase in debt compared to GDP need not much affect economic performance and is regardless a necessary consequence of trying to sustain demand while the virus is brought under control. But it will have a notable long term effect. During the course of the downturn central banks will cut interest rates to rock bottom, if they haven’t already. Because of the increased sensitivity of the economy to debt, central banks will have to keep rates very low even after economies have recovered.
Lower for longer is going to be so low for so long that for many years we can forget about central banks capacity to stimulate economies. They will have none. Central banks will retain their valuable capacity to smooth out liquidity strains and payments malfunctions, and to support debt for firms and households. Yet not even the Reserve Bank of Australia will have any capacity to ease the interest rate burden on households or corporations, below current levels. Central banks will have a general policy effectiveness only in one direction – raising rates. It will be many years before that capacity will be needed.
The Australian federal government will be issuing several hundred billion in new debt, pushing the price of federal debt down and the interest rate up. To maintain its declared ceiling on bond rates, the RBA will have to buy them whenever the rate is likely to exceed its target rate. This is the point of the new policy. It means that the RBA has committed to indirectly funding the new debt intended to carry the economy through to time when the virus is under control. Like many other central banks, the RBA’s balance sheet will rapidly expand.
Fiscal policy will also be constrained, though not so completely. Most governments will be in deficit for a long while, including Australia’s. The big deficits expected this year and next mostly arise from a vast but avowedly temporary increase in spending on one side, and a collapse of tax revenue on the other. Fiscal policy will then turn contractionary as one off measures end, tax revenue begins to recover, and deficits begin to decline.
We learned in the years from 2009 that Australian tax revenue now recovers only slowly from a big downturn. This will be still more evident under the new tax thresholds and scales, with their built-in reductions. Yet the effect will still be contractionary, and perhaps severely.
Many other central banks had less policy space. But from 2011, the RBA was able to offset the impact of a contractionary fiscal policy by lowering the cash rate and sparking a housing boom. That will not be possible this time round. It follows that a sensible fiscal policy will aim to cut the deficit only slowly. It will be quite some time before government debt stops rising as a share of GDP, even if GDP growth returns to trend.
With interest rates even lower for even longer, financial market investors will have to buy shares. If markets valued companies fairly at the mid-February market peak, and if the economy global recovers to the levels of output and expectations of medium term growth which the market assumed in February, then overall equity prices have a very long way to increase. If the market bottoms out 50% below the February peak, for example, it will have to then increase by 100% just to get back to where it was. Unlike the last decade, it will be a stock pickers market. Many companies will emerge burdened with debt. Many tech companies, which lived on promise rather than sales, will find the post slump market uncongenial. Good fund managers may be able to beat the index.
The crisis also has wider implications. It has reminded us of the authority of the state over markets and supranational institutions. At the same time it has reminded us of how much nations have in common with all others, of the inescapable and irreversible fact of globalisation. It has queried the pretensions of the superpowers. In the global contest between China and the US, neither of the proponents have done well.
China quickly controlled the spread of the virus, but its tightly controlled communications also permitted the virus to get a hold, and not just in China. The US has plenty warning yet was unprepared for the epidemic when it hit, and fumbled the early stages of testing and isolating. The most successful countries in dealing with the virus have been Singapore, Taiwan, Hong Kong and Korea – all, like Australia, relatively small and with good health systems. In this crisis the rest of the world owes nothing to the leadership of either superpower.
Although the pandemic started in China, the Asian regional economy, with China at its core, is coming out the crisis faster and stronger than Europe or the Americas. Decoupling from China will seem even more of a fantasy.
It will be a new world, though one with familiar problems. We know about debt overhang and about the limits on monetary and fiscal policy from the past decade. Those constraints will be more pressing in the next.
For its part, Australia is getting by better than might have been expected. Iron ore and coal prices have held up remarkably well. Mining and farm exports look to be okay, at least so far. East Asia, the market for three quarters of Australia’s goods exports was first into this crisis, and looks to be on the way to being first out. Tourism and education will be slow to recover because both industries involve air travel and group activity. Their full recovery probably awaits not only a vaccine but its wide availability.
As for the impact on the idea of globalisation, it is certainly true that countries closed borders against foreigners, that the European Union members closed their borders against each other, and that various restrictions on cross border trade in medical supplies were proposed. Yet it is also true that countries shared information about the virus and its spread, the World Health Organization was able to coordinate and publicise high frequency data, and that countries learned from each other about ways to control the virus and treat the victims. So too the economic remedies have been broadly the same in most countries It was a universal, shared experience. Like individuals, countries were both isolating and communicating. For a while nations have more in common than they usually suppose.
It will be a new world, though one with familiar problems. We know about debt overhang and about the limits on monetary and fiscal policy from the past decade. Those constraints will be more pressing in the next. In the last decade we became familiar with low productivity growth and faltering business investment. It will be a while before investment levels return to where they were at the beginning of this year, let alone move beyond them. Productivity growth will appear to be spectacular for a quarter or two as economies resume full production, then it will fade.
Still, after coronavirus, the sluggish performance of the past decade will be pleasingly recognisable.
The Covid-19 outbreak has rapidly gone from a crisis for China to a crisis for the world. The pandemic is desperately crying out for international leadership.
So far that has been sorely missing. An extraordinary (virtual) meeting of G20 leaders, to be held on Thursday, will hopefully begin rectifying this.
Many are looking to the G20 to provide the same kind of leadership it did during the 2008–09 global financial crisis. In fact, the need for strong global action goes vastly further this time around.
The G20 should commit now to quickly developing, funding, and rolling out a global health effort to help emerging and developing economies manage what could be an explosion in devastating health disasters.
The global financial crisis was really a North Atlantic crisis, with the core problems lying within the tightly interwoven financial systems of the United States and Europe. Those two getting their own houses in order – or at least re-establishing stability – was the single greatest service to the rest of the world they could provide.
The G20 complemented this by delivering a coordinated stimulus, guarding against a descent into beggar-thy-neighbour protectionism, and supporting the rest of the world via increased funding for the International Monetary Fund and multilateral development banks. That helped restore global confidence, limit the damage, and enable the recovery.
Covid-19, by contrast, is a truly global crisis. As the pandemic intensifies, countries around the world are simultaneously not only facing a dramatic external shock but a massive internal one as well – in the form of national health crises and related public shutdowns coming at high economic cost.
Most worrying, the obvious next stage of the Covid-19 crisis risks being a health and economic disaster in the emerging and developing world. Weak health systems, low state capacity, poverty, slums, inadequate safety nets, and little ability to fund their own policy responses mean the human and economic costs threaten to be far more devastating than what we have seen to date. There is some speculation that the virus doesn’t spread as easily in tropical climates. But that remains unproven.
Acknowledging this harsh reality is fundamental to thinking about the global ambition required.
The key for the G20 is to begin taking concrete steps while sending a strong signal they are willing to do “whatever it takes” depending on how things evolve – echoing the famous words of former European Central Bank president Mario Draghi at the height of the Eurozone debt crisis.
Today, a truly global crisis requires a global “whatever it takes”. The need is in two broad areas.
The first is delivering a large-scale global health response. The G20 should commit now to quickly developing, funding, and rolling out a global health effort to help emerging and developing economies manage what could be an explosion in devastating health disasters. The World Health Organization could lead in coordinating the response and mobilising funds.
This needs to be coupled with more immediate actions, in particular urgently removing the array of export restrictions on critical medical supplies recently imposed by many countries, including G20 members. These are particularly insidious beggar-thy-neighbour policies, and will hit smaller and poorer countries with little domestic industrial capacity the hardest.
The second priority is on the economic front. The need is not just about coordinating expansionary fiscal and monetary policies as in 2009 but also about ensuring that as many countries as possible are actually able to undertake such measures in the first place.
Most emerging and developing countries, including G20 members such as India, Indonesia, and Mexico, simply cannot finance the kind of massive fiscal expansions – on the order of 10% of GDP and possibly higher – that many advanced countries are currently pursuing to save their own economies.
Many currencies are already plunging, and an emerging markets crisis is now a distinct possibility – with the risk that events in one country could easily spark wider financial contagion and collapse.
Underwriting financial stability and enabling the fiscal expansion needed in these countries will require a large and multi-faceted effort – deploying and dramatically expanding tools including central bank currency swaps, IMF liquidity and balance of payments support, and large-scale budget financing loans from multilateral development banks. For the poorest countries, international aid will be critical.
All of this may need to go far beyond the scope and scale of that delivered during the 2008–09 crisis. Positively, the IMF has begun raising important new proposals that could help. The G20 should heed this advice but also be prepared to go much further.
Importantly, the rationale for a global “whatever it takes” is not too different to that justifying the massive increases in spending currently underway in advanced economies – namely, incredibly low borrowing costs and high returns to acting now to stave off the far worse alternative.
Conversely, the costs to not doing whatever it takes could be catastrophic. And not just in terms of the human and economic toll. It could also deliver a fatal blow to any remaining idea of a stable global order – especially one underpinned by liberal values and led by the United States and its allies.
It goes without saying that the medical response to the pandemic should have the highest policy priority ... On the economics of the pandemic, initial reactions have been quickly outdated. Originally published in The Australian.
It’s quite a while since I was at the Reserve Bank, but one of my tasks there was to draft replies to letters received. So let me try my hand at responding to Christopher Joye’s "Virus gets upper hand in battle against central banks" (AFR, March 13). Originally published in the Australian Financial Review.
Panic has now set in over the Covid-19 global pandemic. The coronavirus is spreading rapidly, especially in Europe and the US, and severe public-health measures are being put in place and are set to intensify. At the same time, economic policymakers are deploying their own emergency policy responses, and financial markets are either plunging, freezing up, or whipsawing all over the place.
With the worst yet to come, we are perhaps at the point of greatest fear and uncertainty. The first priority is to get the public-health response right – the only way to limit both the human and economic cost.
People come first. But the economic threat posed by the virus is also extremely serious, and the response needs to be correct. The last thing the world needs is for a devastating pandemic to be accompanied by a deep economic crisis, prolonged stagnation, and the attendant social damage and political dysfunction that would likely result.
The focus now needs to be on funding whatever is necessary for public-health systems to respond most effectively while providing financial relief to hard-hit households and businesses to cope through the peak of the crisis.
A global recession already looks inevitable, at least by the standard of the International Monetary Fund, which classifies global growth at 2.5% as signifying a world recession. With what has already happened, particularly in China and with global growth last year at only 2.9%, we are already looking at something well below that. As the crisis goes global, an outright contraction in 2020 is very possible. The question is how deep and how long it will be.
What are the immediate priorities for economic policy? This is a particularly unusual and uncertain crisis. Much will depend on how deep and how long the health crisis itself proves. But a few things seem clear.
The starting point is recognising that the social distancing required to slow the virus – both voluntary and mandated by governments – means the economic hit is going to be large, and there’s probably not much that traditional demand-stimulus policies can do to materially counter it. In part, that’s because people won’t go out to spend the money, but it’s also because the virus is an intensifying supply-side shock as well – with big disruptions to normal business activity and many workers pulled out of work, either for health reasons or as workplaces and schools are temporarily shut down.
The first-order economic damage of the virus will therefore be difficult or impossible to counter in any significant way. The focus instead needs to be on countering the second-order economic effects of the virus that could either deepen the short-term damage or lead to longer-term economic costs.
Stimulus is not the main game. That comes later when countries can more realistically start thinking about recovery.
Instead, the focus now needs to be on funding whatever is necessary for public-health systems to respond most effectively while providing financial relief to hard-hit households and businesses to cope through the peak of the crisis. The goal of financial relief is to prevent otherwise sound businesses from going bankrupt, to keep workers from being unnecessarily dislocated, and to stop massive loan losses from hitting banking systems and precipitating a financial crisis.
Supporting households is also critical from the broader perspective of protecting the vulnerable while also perhaps reducing any pressure some might feel to go out and work when they should be self-isolating.
The market cannot handle this problem. Socialising the costs via government budgets will be necessary. Fortunately, long-term government borrowing costs are incredibly low these days – below zero after adjusting for inflation – so there is plenty of scope to do so.
Central banks around the world, led by the US Federal Reserve, are also stepping up with emergency interest-rate cuts, liquidity injections, and asset purchases (quantitative easing), while regulatory controls on banks are being temporarily loosened. The focus is less on stimulating demand for the reasons given above and more about easing funding constraints, preventing financial markets from seizing up, and keeping credit flowing to households and businesses that would otherwise face their own funding squeeze.
Beyond these elements, there is a dire need for international cooperation. Independent central banks have already been coordinating in earnest. But international coordination among governments has so far been extremely lacking.
There are now signs the G7 and G20 might finally be more actively mobilised. The need goes far beyond coordinating emergency economic policies.
Until now, haphazard and beggar-thy-neighbour health policies have been the order of the day – from disjointed travel bans causing chaos to far more worrying export restrictions on critical medical equipment, including face masks and respirators. Not only does that mean that the right medical equipment potentially won’t be available where it’s most needed, but in a world built on fragmented global supply chains, few countries (if any) are likely to be fully self-sufficient in this regard. In other words, it could lead to everyone being made far worse off.
Strong global coordination is desperately needed. Unfortunately, today’s world is beset by crude populism, partisan politics, and zero-sum geopolitics. The virus, of course, is not hampered by such problems. The world cannot afford to be, either.
The novel coronavirus, or Covid-19, has spread throughout the world in three short months. Outbreaks have been reported in more than 50 countries, there are 88,000 confirmed cases, and at least 3000 people have died. But while the numbers of new cases and deaths in China might be steadying (based on official figures, the accuracy of which is uncertain), the numbers outside China are increasing at a worrying pace.
While the vast majority of cases are still within China, there have been more new cases reported outside of China than within China since 25 February. And the number of confirmed cases outside of China has already outstripped SARS, the viral respiratory disease caused by a coronavirus in 2002–03. In just over a month, there have already been more than 6000 cases of Covid-19 outside of China. By contrast, there were approximately 3000 cases of SARS outside China in the first three months of the outbreak.
The World Health Organization (WHO) has been reluctant to label the novel virus a pandemic. WHO is walking a fine line between leading a global healthcare response, retaining access to China, and avoiding panic. Its constant praise for China’s efforts to combat the virus has attracted criticism, though others claim this was the best way to secure access for the WHO observer team to China.
The head of WHO, Tedros Adhanom Ghebreyesus, has said that “using the word ‘pandemic’ now does not fit the facts, but it may certainly cause fear. This is not the time to focus on what word we use.” The organisation last declared a pandemic when H1N1, or swine flu, infected approximately 61 million people in the US alone in 2009. It was accused of exaggerating the threat, and WHO officials fear that the word ‘pandemic’ would lead to panic.
This stands in contrast to the response of US and Australian authorities. The US Centers for Disease Control and Prevention (CDC) spokesperson Benjamin Haynes said on 26 February that the novel coronavirus has already met two of the three criteria for a pandemic, and the world was moving closer to meeting the third criteria. The CDC has said that a coronavirus outbreak in the United States is a matter of when, not if. In doing so, US health authorities have essentially contradicted the claims of US President Donald Trump that “because of all we’ve done, the risk to the American people remains very low”. The Australian government has activated its pandemic emergency plan, as new cases were reported over the weekend in countries as widespread as Azerbaijan, Ecuador, and Ireland.
It’s worth noting that a pandemic declaration did not happen during the SARS outbreak. A pandemic is often declared after efforts to contain an outbreak in specific regions or countries fail. The idea is that such a declaration will prompt governments to switch from containment measures (quarantining individual cases) to mitigation (shutting schools and other mass gatherings to slow the spread). A number of WHO officials have expressed concern at the binary nature of government responses: they would prefer governments be focused on containment and mitigation, rather than one or the other.
The rapid spread of the virus outside China also drastically raises the economic stakes. The shock to the global economy now looks like it is going to last much longer and be potentially far deeper than was thought just a few weeks ago. The hope that the economic hit might be painful but short-lived looks increasingly unrealistic. The case for governments and central banks to provide immediate policy support has gone up.
Much will ultimately depend on the effectiveness of the public health response of governments around the world.
WHO’s Tedros said “The steps that China has taken to contain the outbreak at its source appear to have bought the world time”.