The Covid-19 crisis is now widely seen as the greatest economic calamity since the Great Depression. In the Pacific, as in the rest of the world, economic activity has collapsed as a result of lockdowns to contain the virus. As an aid dependent region, a critical question is whether enough outside support will be made available to help Pacific governments keep their economies and societies afloat through the pandemic.
By our estimate, the Pacific’s development partners have so far announced around $825 million (US $570 million) in Covid-19 related financial support, including the debt standstill announced by the G20 in April. That’s equal to about 1.7% of the region’s collective output, not insubstantial. It is also rising as more announcements are made. Nonetheless, it’s still well below the 10% of GDP and upwards being deployed in many advanced economies, including Australia.
Not all the announced amounts are additional. Australia has announced a Covid-19 package for the Pacific worth $100 million but with all of this coming from the existing aid budget. Some reprioritisation of existing support undoubtedly will have made sense. There may also have been some additional funds freed from projects put on hold or delayed due to the virus. The World Bank, and the Asian Development Bank (ADB) for their part have so far announced $143 million in combined Covid-19 response measures, coming from a mix of reprioritisations and stretching their balance sheets.
At the global level, the headline grabbing news has been the debt servicing standstill announced by the G20 for the poorest countries (including most of the Pacific Islands countries). The standstill only applies to debt owed to bilateral creditors and lasts until the end of the year. By our estimate, this year’s bilateral debt relief (including a hold on this year’s PNG’s repayment of Australia’s $440 million) accounts for around 60% of total debt servicing costs in the Pacific or about 1% of regional GDP. Most of this reflects the standstill on Australia’s one-off exceptional loan to PNG. Without this, the standstill would only be worth about 0.2% of regional GDP (and 28% of total debt servicing). The bulk of this smaller amount reflects bilateral Chinese loans. Notably, though China has doled out many large loans in the Pacific over the past decade or so, these are still operating in their interest-only phases – meaning debt servicing to China is still quite small.
More important than the debt standstill could be the decision by the G20 to endorse an expansion of the rapid financing windows of the International Monetary Fund (IMF). Ordinarily, countries can access up to half their IMF quota in a year and 100% on a cumulative basis (quotas being in reference to each country’s IMF voting rights). This has now been expanded to 100% and 150% respectively. The amounts on offer come with limited IMF conditionality and, at least for the Pacific, are very sizeable – equal to 3.5% of GDP for the average Pacific economy and over 8% of GDP for Kiribati and Tuvalu. So far, the IMF has only announced a rapid financing package for Samoa and Solomon Islands but approvals for other Pacific countries might also be in the works, noting the IMF says more than 100 countries have requested emergency help.
What more could be done in the near term?
Extending the debt standstill could be especially beneficial for the Pacific, given multilateral debt is quite significant.
One simple step would be to extend the duration of the G20 measures already announced. Currently the debt standstill will expire by the end of the year and enhanced access to the IMF rapid financing windows will revert back to normal levels from 5 October. Yet, financing needs in response to Covid-19 will likely persist well beyond these arbitrary dates, in the Pacific and elsewhere. Continued support will be needed. Extending these existing measures to the end of 2021 would be a relatively uncomplicated further step.
Another obvious step would be to broaden the bilateral debt standstill to multilateral and private sector creditors, as the G20 has already called for. Extending the debt standstill in this way could be especially beneficial for the Pacific, given multilateral debt is quite significant. According to our estimates, this could free up an additional 0.8% of GDP for the average Pacific economy or around $400 million across the region.
The IMF could also expand the total amounts available under its rapid financing windows. The IMF has a trillion-dollar total lending capacity. Many have argued this may not be enough for the current crisis. Yet, as Brad Setser of the Council on Foreign Relations has pointed out, the current risk for the IMF looks more like it could end up lending too little to too few.
A relatively straightforward way for the IMF to get more money out the door would be to simply substantially expand the maximum amounts available under its rapid financing windows. Another option would be for the IMF to issue a new round of Special Drawing Rights, though this has already been raised by many leading figures while the United States has remained opposed at least for now.
Finally, bilateral development partners like Australia could of course do more. Ideally by providing more grants but also via additional loans, if need be.
“People who invest in aviation are the biggest suckers in the world.” – David Neeleman, founder of JetBlue Airways
“If you want to be a millionaire, start with a billion dollars and launch a new airline.” – Sir Richard Branson, founder of Virgin Atlantic Airways
The last few years have been busy for the airline industry in the Pacific Islands. Lured by more modern, fuel-efficient and smaller aircraft with greater range, flag-carrying airlines across the region made big plays to trade up their ageing fleets. In the last three years, more than 24 new planes were on order or had been delivered for eight regional airlines, tallying more than US$2.5 billion in new leases. For some, such as the purchase by government-owned Air Kiribati of two Embraer E190s, the investments were huge, equivalent to roughly half the country’s annual GDP.
The primary goal for the fleet renewal is simple: to boost tourism. But national carriers in the Pacific also fill a critical public utility, bolstering inter- and intra-connectedness in a region of low population density and extreme remoteness. To this end, most national carriers in the region are partly or wholly government-owned, or at the very least directly subsidised by their government or indirectly protected through complicated seat-capacity or airport-capacity limitations.
With thin traffic and freight levels for many routes, the economic performance of these airlines over the years has been mixed at best. But it’s a cost most governments are willing to wear in return to for the public utility function – and prestige – that a national carrier provides.
The regional solution is a romantic one, and an aspiration for many elements of governance and service delivery in the Pacific region.
In 2020, however, these costs are set to skyrocket. The grounding of planes as a result of Covid-19 movement restrictions has devastated the global airline industry, and the Pacific is no exception.
Fiji Airways, the largest and oldest regional airline built around tourism, has just this week been forced to lay off half of its workforce and is pushing for a government-backed A$227.5 million loan to keep them afloat.
Papua New Guinea’s Air Niugini had just turned itself around this year, after years of losses and a confidence-shaking crash in the Marshall Islands in 2018. It may be in better shape as domestic flights in the country resume, but even beyond the first $10 million provided, a handout could still be needed. The resignation of CEO Alan Milne, who had steered the company back to profitability, is another setback for the airline.
Air Kiribati, Air Vanuatu, Nauru Air and Solomon Airlines are all in similar situations, but at most serious risk is Samoa Airways. Relaunched in 2017 after the Samoan government ditched its partnership with Virgin, the budding international airline has faced a number of setbacks. The grounding of its brand-new Boeing 737-Max, expensive “wet-leasing” of a temporary plane and turmoil in the airline’s leadership team are just some of its headaches. Virgin Australia entering administration, the cancellation of Fiji Airways flights to Samoa by the Samoan government and the ending of Samoa Airways’ current leasing option will leave Air New Zealand as the only carrier connecting the nation’s glistening new China-funded international airport – and the nation as a whole – to the outside world.
Many are guessing how far the industry shakeout will go, and who will remain as the world starts to open up again. For Pacific governments, it will test how much they value their national carriers as they are forced into even greater subsidies and bailouts.
One option being suggested is the potential for national carriers to amalgamate into a single regional airline, or a set of sub-regional airlines to service Melanesia and Polynesia respectively. It is an enticing solution – potentially generating efficiencies and reducing duplication of services through increasing overall scale. If such a regional carrier had ownership stakes from all Pacific governments, they could ensure profit-making parts of the enterprise supported loss-making routes that serve the public utility and connectivity functions so critical for many national carriers.
The regional solution is a romantic one, and an aspiration for many elements of governance and service delivery in the Pacific region. It’s also not an entirely new ambition for Pacific airlines, as detailed in this 2007 ADB report, with Fiji Airways having its beginnings as a regional carrier. In 1970, then named Air Pacific, seven Pacific Island governments, some still under British rule, held shares in Air Pacific, and were serviced by the carrier. Within a decade, the regional model had lost the confidence of all its members, who each pushed on with establishing their own airlines and the evolution of Air Pacific into the national carrier Fiji Airways we have today. A recap of the state of affairs of Pacific airlines in 1981 by the New York Times could be read 40 years on as all too familiar.
While there are practical limitations to a regional airline – the distance between Palau and Cook Islands is 8000 kilometres, equal to a return flight from Sydney to Perth – the real impediment is political. Inter-island rivalries, a failure to secure consensus on operational issues, and the critical question of control have thwarted previous efforts for a shift towards regionalism.
Another option is for Pacific governments to liberalise international routes to international carriers from developed nations. Greater competition would undermine the profitability and performance of their own carriers, but the benefits of potentially more international arrivals could be used to subsidise non-commercial domestic routes that keep these countries connected. In this scenario, governments would be required to give up something they greatly covet – control.
Either way, Covid-19 is going to force Pacific nations to think much harder about their flag-carrying airlines. Do they remain a critical public utility, or as they haemorrhage money will they be a luxury that stretched budgets can no longer afford?
In Episode 12 of COVIDcast, Roland Rajah, Director of the International Economy Program, sat down with Brad Setser, Senior Fellow for International Economics, Council on Foreign Relations, to discuss the upheaval brought about by the pandemic in emerging economies and what this has revealed about the importance of the US dollar in the functioning of the global economy.
Rajah and Setser began by discussing the dramatic outflow of capital from emerging markets between March and April. Setser described this as “the most rapid withdrawal of foreign financing that anyone had seen since the global financial crisis”. Although markets have since stabilised largely due to the intervention of the Federal Reserve (the Fed), a number of economies remain very fragile. As Setser put it:
“So long as oil prices remain low, or tourism remains shutdown, or if you needed foreign financing to roll over your debt, foreign financing remains scarce … Even though the most important shock and the peak of market stress is past, some countries are living off buffers and borrowed time.”
Setser also noted that while the Fed had reacted creatively and forcefully, the International Monetary Fund had been left on the sidelines and had yet to offer a crisis facility that is attractive to the big emerging markets.
On the role of the US dollar as global reserve currency, Rajah questioned the ability of emerging markets to wean themselves off dollar dependence. Setser argued the US dollar remains the most used to denominate world trade and financial assets – “as long as that’s the case, in a crisis you’re going to need dollars”.
Despite China’s goal to establish the RMB as a global reserve, the crisis and the response of the Fed, including providing dollar swap lines, had reinforced the dominance of the US dollar.
The US dollar remains the most used to denominate world trade and financial assets – “as long as that’s the case, in a crisis you’re going to need dollars”.
Given this dominance, Rajah asked why the United States did not actively take advantage of the dollar as a powerful tool of attraction in its competition for influence with China, and whether it had been too selective in the countries to which it offered swap lines. Setser said “the Fed’s mandate doesn’t include providing political swap lines to gain political influence” yet also that “the United States hasn’t made full use of its financial power”. America could try to compete with China to provide financing for infrastructure as well as financing in times of crisis through the Treasury’s balance sheet, he said.
Rajah concluded by asking what emerging economies could and should do to get through the current crisis. He noted everyone needs to run large fiscal deficits, but, in the absence of outside help, emerging economies are turning to their own central banks in unconventional ways reminiscent of quantitative easing in advanced economies. Setser argued it was a balance of risks versus benefits, and that each country has a choice to make, “between a weaker currency and easier access to central bank financing for fiscal deficits”.
COVIDcast is a weekly pop-up podcast hosted by Lowy Institute experts to discuss the implications of Covid-19 for Australia, the Asia-Pacific region, and the world. Previous episodes are available on the Lowy Institute website. You can also subscribe to COVIDcast on Apple Podcasts, listen on SoundCloud, Spotify, Google podcasts or wherever you get your podcasts.
Papua New Guinea has grappled with economic instability for years, exacerbated by generally declining global commodity prices, increasing national debt and allegations of fiscal mismanagement. None of this is helped by high rates of population growth and unemployment. Now the coronavirus pandemic will deliver a further blow to the nation’s extractive economy as the world enters a recession and demand for resources drops.
Health-wise, the Pacific Island state is one of the more fortunate countries, so far, with only a handful of confirmed Covid-19 cases and no fatalities.
But the resource dependence which PNG has promoted since independence won’t be a strength. The returns of the sector, already associated with poor job creation and failure to drive inclusive development, will further diminish. Before the virus outbreak, resources contributed 29% to the country’s GDP, and more than and 10% of government revenues. But in recent years volatile world markets and too much spending in advance of revenue delivery, leading to mounting debt, have significantly wiped out the anticipated benefits for development. A sovereign wealth fund intended to secure long-term revenue savings is not yet operational.
The government was planning record expenditure this year. Yet the Covid-19 outbreak has now left a glaring 2 billion kina (A$890 million) budget shortfall and national debt could surpass 40% of GDP by the end of the year. Meanwhile the country’s growth is forecast to decline to -0.2% this year.
This, as well as the state of emergency provisions, will affect the nation’s 8.6 million people, of whom about 40% already live below the poverty line.
Local PNG economist, Busa Jeremiah Wenogo, has long advocated the development of small and medium enterprises and the informal economy in PNG to boost sustainable livelihoods. But he has warned that social distancing and banning of gatherings places “almost 80 percent of our nation’s workforce in the informal economy in a dire situation”.
Likewise, in a recent interview Paul Barker from PNG’s Institute of National Affairs identified the vulnerability of those with greater dependence upon cash crops for their livelihoods. “[People] living in areas of higher population density, including on oil palm settlement schemes [have] little, if any, land set aside for food production,” Barker told me.
In rural communities, where more than 80% of people reside, subsistence agriculture on customary-owned land remains the bedrock of household self-sufficiency and this will go a long way to maintaining rural food security. The country’s customary or traditional governance also plays an important role in local-level resilience. In times of great need, many families and communities instinctively turn to their head of clan or village chief for direction and support, rather than politicians. It’s likely such coping strategies will come to the fore during the weeks and months ahead.
However, in more crowded urban centres, where people don’t have the same access to land or social support structures, loss of incomes and poor food security could lead to a rise in crime.
Nothing incenses Papua New Guineans more than the suspicion or knowledge that their lives are stricken by hardship because of high-level corruption.
Large-scale violence or conflict is a different scenario. In PNG’s post-Independence history, apart from tribal warfare, this has been mostly connected with local grievances about the nature of foreign involvement in the economy. The most obvious and deadly example was the Bougainville civil war (1989-1998), triggered by anger over environmental damage and inequity associated with the then foreign-owned Panguna copper mine. More recently, landowner grievances about the Exxon Mobil co-venture, PNG LNG, and the Barrick Gold majority-owned Porgera gold mine in the highlands have resulted in violent skirmishes.
Having witnessed decades of under-development alongside massive resource projects, there is nothing that incenses Papua New Guineans more than the suspicion or knowledge that their lives are stricken by hardship because of high-level corruption. A special grevience is the idea of foreign companies taking the land’s wealth and at the same time leaving them poorer. For most citizens, there is a difference between suffering and hardship which has a comprehensible cause and that which is the result of social injustice.
Despite Covid-19 placing an enormous strain on our Pacific neighbour, Barker’s assessment appears sound, that “there should be no reason for chaos or PNG turning into a failed state, although many of its institutions can long be deemed as failing, or severely deficient.”
And though it is too early to judge, further political strength may come from Prime Minister James Marape, who came to power last year. Maraphe has adopted a more assertive stance with foreign investors in resource projects, claiming to better represent his nation’s interests. The emergence of Covid-19 coincided with Marape’s attempt to end Barrick Gold’s involvement in the Porgera mine and amend the terms of the proposed P’nyang gas extension project agreement with Exxon Mobil. Despite the courts ordering the government back to negotiations with Barrick Gold, Marape’s approach is what locals have demanded for a long time. The security and “trust” environment for foreign investors won’t improve unless Papua New Guineans see better returns.
PNG is still ranked a nation of “low human development”: life expectancy is 64 years, barely a quarter of the population have access to reliably mains electricity, and just over half of people in urban areas have improved sanitation (in rural areas, this the rate is less than 15%).
So the pandemic, if anything, highlights the urgency of maintaining a focus on diversifying the nation’s economy to better ride global events and uncertain world markets. Diversification became a core part of the government’s budget policy two years ago. Before the coronavirus outbreak, public expenditure was tuned to stimulating agriculture and the private sector, alongside investment in infrastructure and services, such as roads, power, and digital connectivity.
The government is making cautious moves to lift some of the internal lockdown restrictions. This will lead to improved conditions for the local economy. But it will be important, in carrying the country through this crisis and preserving stability, to not lose sight at the national level of the long-term needs, such as rigorous fiscal management, and more diversified and resilient employment for millions of Papua New Guineans.
Last weekend news broke that the Chinese government was considering imposing large tariffs on Australian barley exports. Now, China-bound exports from four Australian meat processors have been suspended.
Following Australian calls for an independent inquiry into the early handling of Covid-19, China’s Ambassador to Australia Cheng Jingye warned that Chinese consumers might respond by boycotting Australian exports, mentioning tourism, education, wine and beef. The government pushed back, with Foreign Minister Marise Payne cautioning China against responding with “economic coercion”.
These latest moves, which have nothing to do with the choices of Chinese consumers, suggest that that caution has been ignored. Rather, the moves follow a familiar playbook, in which the Chinese government relies on technical regulatory measures to restrict exports, while denying any retaliation is taking place.
The technical story behind barley and beef
The prospect of barley tariffs is neither sudden nor unexpected, but the culmination of an 18-month investigation into allegations that Australia violated World Trade Organisation (WTO) rules by providing subsidies to exporters, assisting them to sell (“dump”) large volumes of barley at low prices in China.
The deadline for concluding the investigation is 19 May. If Beijing believes Australia has broken the rules and wants to respond with anti-dumping tariffs, it must do so this month.
These technical justifications are strikingly similar to past cases of economic sanctions by the Chinese government.
Industry bodies and the Australian government strenuously deny any violation of WTO rules. When the investigation was first announced, some analysts wondered whether it was retaliation for earlier anti-dumping actions taken by Canberra against Beijing. This possibility was again raised this week, including by Prime Minister Scott Morrison.
Morrison said he expects China to keep politics out of its final decision, while China’s Foreign Ministry spokesperson described a “normal trade remedy and investigation”.
Labelling and health certificate requirements are apparently the issue with beef. Similarly, there is precedent for Australian meat producers falling foul of Chinese labelling rules, with six meatworks banned for three months in 2017. As with barley, the Australian government has so far downplayed the idea that the current suspensions are retaliatory, with Trade Minister Simon Birmingham saying he sees “no relationship” with the Covid-19 inquiry.
The political story: Covid-19 and economic coercion
These technical justifications are strikingly similar to past cases of economic sanctions by the Chinese government.
The defining feature of China’s unilateral economic sanctions is their informality. Rather than publicly announcing formal legal sanctions and linking them to a foreign policy dispute, Beijing typically denies that it is imposing economic punishments while explaining disruption to trade by reference to other plausible justifications.
Consider two examples. After the Philippine navy confronted Chinese fishing boats near a disputed area of the South China Sea in 2012, Filipino bananas rotted in Chinese ports after customs officials declared the fruit did not meet Chinese health standards. When Seoul installed a missile defence system over Beijing’s objections in 2016, South Korean conglomerate Lotte saw 74 of its 112 supermarkets inside China closed for alleged fire safety violations.
Informal retaliation provides “plausible deniability” against any charge of violating international trade rules, or accusations of explicit economic bullying. It also allows greater flexibility to deescalate retaliatory measures without appearing to be backing down from a dispute.
Like labelling rules or domestic health and safety regulations, WTO laws also provide avenues for plausibly deniable economic coercion.
While the proposed barley tariffs might appear to be remedies for Australia’s alleged violation of WTO rules, they may instead be legally “dressed up” informal economic sanctions.
As China has become increasingly adept at utilising WTO law, it has used trade rules for many legitimate purposes but also to retaliate against investigations and counter-measures introduced by other actors. Such retaliatory use of WTO law, particularly against the United States and European Union, has been extensively documented.
WTO rules also appear to have been leveraged by China as an additional means of imposing economic punishments during political disputes. The complexity and often highly contestable nature of anti-dumping investigations make them particularly conducive to maintaining plausible deniability.
Why target barley and beef?
If politics is a factor, part of the reason will likely be timing, because the imminent conclusion of China’s barley investigation provides the perfect legal mechanism to use as cover. In this telling, but for Australia’s call for a Covid-19 inquiry, Beijing would not be considering tariffs – an outcome some seemed cautiously optimistic about last year.
For beef, the logic would be the precedent of earlier labelling issues. Regardless of the merits of these concerns, the continuation of an existing issue provides a response to accusations of economic coercion.
The existence of plausible deniability means that the case that Beijing is leveraging barley and beef to make a political point is circumstantial.
Regardless, this episode illustrates the consequences of mixing politics and economics in international diplomacy. The spectre of Australian exporters losing two major export markets comes just weeks after China’s ambassador explicitly linked an ongoing political dispute to economic repercussions.
That linkage has now undermined the credibility of Beijing’s assertion that barley is just a “normal” investigation, or that labelling is the major concern with Australian beef exports.
Even if tariffs are not imposed and the beef issue is quickly resolved, the perception of China as an economic bully could well persist in the minds of some Australians. If it wanted to, Beijing could do much more to allay these fears.
While the Canberra political establishment has been sparring with China’s Foreign Ministry – and with Australian billionaires – much of the corporate elite has begun puzzling how to slipstream China’s post–Covid-19 economic recovery.
Optimists hope that Beijing will summon a massive infrastructure stimulus, triggering a commodity boom, as happened after the global financial crisis in 2009.
China’s emergence from the pandemic has been slower than expected, with some public health controls becoming institutionalised, and with second-order economic effects being felt via lost export orders and jobs. Life is returning to normal in most provinces, but strict neighbourhood-level monitoring, testing, and social distancing remain in place. China – as Australia – can’t relax fully while the virus is still spreading internationally.
While infrastructure stimulus remains China’s first line of response to economic emergencies, the government insists that this time the new public works will be different.
New locally transmitted cases are still being reported, so school openings have been postponed, and cinemas closed again after briefly reopening.
China business analysts Gavekal Dragonomics say that two thirds of people are back in workplaces, but most still can’t obtain door-to-door deliveries, only half have visited a shopping mall this month, and all must still quarantine if travelling beyond their city of residence, and again on return.
Gross Domestic Product fell 6.8% in the first quarter. The IMF is forecasting a recovery only to 1.2% growth for all 2020. Exports – which comprise about 18% of GDP – are expected to fall by up to half in the first quarter, and industrial profits by 25% in the first half.
Last year, government debt grew faster than in a decade, since the post-GFC stimulus kicked in. At the start of 2019, total Chinese debt was about $US40 trillion – 304% of GDP and 15% of total global debt. The PRC had started a deleveraging campaign, but the US trade war halted it. Thus, credit limits had been eased again, and local governments were allowed to issue special-purpose bonds – chiefly for infrastructure. But such stimulus programs have achieved ever-diminishing productivity gains, and the misallocated investment has become vast – a quarter of urban apartments now stand empty.
And Chinese financial institutions, led by China Development Bank and China Export-Import Bank, have provided massive capital for Belt and Road Initiative projects, funded almost entirely by loans. The capacity to repay – certainly, within the schedule agreed – must now surely come under question, thereby limiting such institutions’ future stimulus roles.
So where will Beijing turn to restore growth? Some clarity should come at the postponed National People’s Congress, opening on 22 May, where Premier Li Keqiang will deliver the government’s “work report”, and then more when the 14th Five-Year Plan is launched early next year. While infrastructure stimulus remains China’s first line of response to economic emergencies, the government insists that this time the new public works will be different.
Dan Wang of Gavekal says Beijing is promising a boost in “new infrastructure” – including artificial intelligence and big data, but with the 5G mobile network the main priority.
“All that’s missing,” says Wang, “are good reasons for consumers to actually use 5G. For now, it remains a solution looking for a problem: it boasts faster speeds, higher data flow and more device connections, but current 4G speeds are enough to satisfy consumer needs.” This 5G push is therefore likely to disappoint as a near-term stimulus policy, he says.
China is almost certainly oversupplied with old-school infrastructure like power stations and railroads, but it hasn’t yet found new technologies that can absorb similar amounts of stimulus money.
The China-US trade war may also reignite. A clause allows for fresh negotiations “in the event of a natural disaster or other unforeseen event” – which China could invoke as it is required to buy $US200 billion of new US energy and agricultural products, a great challenge in this collapsed economic climate. Otherwise, trends already underway before the pandemic may resume, some more intensely.
Accelerated by the trade war, companies from Japan, South Korea, and Taiwan had already begun to restructure the great Asian value chains, investing more both at home and in third countries such as Vietnam and Indonesia, to lessen risks associated with overdependence on China, including Beijing’s propensity to prioritise politics over economics.
The withdrawal of the massive South Korean chaebol Lotte from China, where it had invested $A10 billion, in the face of Chinese sanctions over new Korean missile defence, provided a stark example.
Robotification is another trend likely to accelerate post-pandemic. And market analysts China Skinny say that China’s online and offline retail is becoming dominated by a handful of large tech companies.
China’s middle class is likely to resume, whatever Beijing thinks, its search for overseas havens, via property purchase, business development, and/or student education.
Australia invests little directly in China – its $13.5 billion is a billion less than it has invested in Papua New Guinea. But a quarter of imports come from China, and a third of exports go there – three quarters comprising just four commodities: iron ore, gas, coal, and gold. Quantities are holding steady. Income from Chinese students in the last financial year was $12b billion, and from Chinese tourists $4 billion. Obviously, these revenues will fall.
Business commentator Alan Kohler wrote recently in The Australian that “for Australian businesses that have China as their plan A, they should start thinking about plan B.”
A degree of international decoupling is indeed inevitable in the wake of the virus, when China’s economic growth will continue to slow. Firms that have focused their international planning chiefly on a country’s – especially China’s – GDP growth may need to think again.
But that doesn’t mean junking plan A. The Chinese market will remain massive and will continue to reward those who can build and keep good relationships, and who pay close attention to its constant changes, especially to its multilayered politics.
The Covid-19 pandemic means that more low- and middle-income economies are more reliant on multilateral development banks. Despite the media focus on “mask diplomacy” (or the lack of it) from individual countries, most notably China, development bank lending has been the largest external source of rapid response concessional loans and grants to address the effects of the pandemic. This will likely remain the most important external source of concessional funds for these countries to address Covid-19’s aftermath as well.
Fortunately, poorer states in Asia can access funding from the US-led World Bank, the Japan-led Asian Development Bank (ADB), and the China-led Asian Infrastructure Development Bank (AIIB), with two caveats. The ADB’s definition of Asia excludes the Middle East, while no state with diplomatic relations with Taiwan has been granted AIIB membership. The ADB recently tripled its Covid-19 facility to $20 billion and the AIIB doubled its to $10 billion. The World Bank quickly established a $14 billion program at the beginning of the pandemic and has committed up to $160 billion to help countries address the costs over the next 15 months.
The World Bank and ADB entered this pandemic period with some undoubted advantages over the AIIB.
By the end of April, the AIIB had agreed to one Covid-19-related loan, a $355 million one to China.
In comparison, the ADB has agreed to loans and grants worth $4.7 billion for Covid-19 response efforts (13 times more than the AIIB) across 11 regional member states, including $150 million for two projects in China. India, Indonesia and the Philippines each have secured $1.5 billion in ADB loans in this time of great and urgent need.
The World Bank has agreed to loans of $4.4 billion (12.5 times more than the AIIB) across 27 states in Asia. India alone has secured $2 billion in Covid-19 project support from the World Bank. For Middle Eastern and Central Asian states, the World Bank has been the only among this trio to disburse Covid-19 assistance. (The table below provides more detail.)
The World Bank and ADB entered this pandemic period with some undoubted advantages over the AIIB. The World Bank and ADB are larger and much more established development banks with experience in responding to health pandemics. The AIIB still was finding its feet and learning from the World Bank and ADB when this virus hit China then spread to the rest of Asia.
The World Bank and ADB are more diversified development banks with a focus on policy-based financing that is particularly important currently. The AIIB, as indicated by its name, has concentrated mostly on project-based lending. Reflecting these differences in experience and expertise, under the AIIB’s Covid-19 Crisis Recovery Facility, it will “provide policy-based finance only in the form of cofinancing with the WB (and ADB)”.
For those that feared or hoped that the AIIB would supplant the World Bank and ADB to become the leading development bank in Asia, this pandemic is a useful corrective. China may be getting more media coverage for its unilateral Covid-19 assistance in Asia than the US or Japan. When it comes to the development banks each power leads, the story is much different.
Covid-19 Lending and Grants to Asia, $M (end-April 2020)
In this episode of COVIDcast, Roland Rajah, the Lowy Institute’s Director of the International Economy Program, sat down with Rachel Ziemba, Adjunct Senior Fellow at the Center for a New American Security, and Rodger Shanahan, Research Fellow, West Asia Program, to discuss the economic and geopolitical implications of the recent oil price collapse.
Due to the combined effects of a collapse in demand, a glut in supply, and lack of producer co-ordination, last week the price of oil briefly turned negative. Rajah and Ziemba discussed the global economic impacts, with Ziemba arguing that deflation was now a major risk: “Looking particularly at the US economy, we have almost 30 million unemployed and the number is rising. I don’t think labour is going to have wage-setting powers, and retailers and wholesalers are having trouble passing on higher costs to the end user.”
The effects across a range of oil-producing countries were also considered, with Ziemba noting, “Even some of the richer countries are likely to invest less money via their sovereign funds in the region, but also as they face unemployment there will be less remittances set. That’s going to affect countries like Egypt, countries in South Asia and will generally be a hit to consumption across the world.”
The geopolitical aspects of the price collapse in the Middle East were outlined by Shanahan, who commented on the Saudi Arabian Crown Prince Mohammad Bin Salman’s role in initiating an oil price war in early March, and the “additional reputational damage for Mohammad Bin Salman because of his poor decision-making”. He also discussed the particular vulnerability of Iraq among Middle Eastern states, noting that it relies on oil revenue for two-thirds of its GDP and that there is a serious risk of further political instability in that country as oil revenue also fuels public-sector wages.
Finally the panel discussed the role of China. Ziemba commented:
We’ve seen Chinese policy response across the board as being more muted and modest than in past crises ... I don’t see China riding to the rescue, neither do I see countries like India playing that role.
She noted the further economic challenges ahead as “distressed assets com[e] through the pipeline”.
COVIDcast is a weekly pop-up podcast hosted by Lowy Institute experts to discuss the implications of Covid-19 for Australia, the Asia-Pacific region, and the world. Previous episodes are available on the Lowy Institute website. You can also subscribe to COVIDcast on Apple Podcasts, listen on SoundCloud, Spotify, Google podcasts, or wherever you get your podcasts.
While we were once mesmerised by how goods and services could fly around the global economy at the blink of an eye, we have now seen the downside of globalisation, where a virus emanating from a wild animal market in Wuhan an industrial city in the middle of China could spread in a matter of weeks to Northern Italy, Iran, South Korea, and now to the rest of the world.
Unlike other viruses such as Severe Acute Respiratory Syndrome (SARS), which was mainly confined to China and Southeast Asia, Ebola to some African nations, and Zika to South America, coronavirus or Covid-19 has hit all of the major economies of the world at once. And not just a few industries have been affected. Covid-19 has not only smashed anything that involves mass movement of people such as transport and tourism, but it has disrupted global supply chains and of course put great pressure on medical facilities and personnel. It’s even hit fun in sport and recreation (and religion too which can sometimes be fun) as the fear of contagion affects anything involving crowds of people.
So how will coronavirus impact globalisation? I can think of eight ways, just for starters.
First, there’s the immediate impact on world trade. The last “Great World Trade Collapse” was during the Global Financial Crisis of 2008–09, and before that during The Great Depression which kept trade subdued up to further disruption in the Second World War. In the case of the coronavirus six of the nation first hit – China, South Korea, Italy, Japan, the US and Germany – account for 55% of world GDP, 60% of global manufacturing, and 50% of global manufacturing exports. That’s a huge hit on both demand and supply with the knock-on effects of social distancing particularly on services exports. It is very unusual for an external shock to hit so many major economies at once.
Second, there will be a realignment of alliances to reduce the heavy dependence on China. China has aimed to be a significant trading partner with all major nations to be able to have bilateral overshadow multilateral or regional partnerships. This is part of the “Belt and Road” strategy, but the pandemic exposes the world’s reliance on Chinese global supply chains. The slow response of China to the virus in Wuhan, allowing it to go global (and also stockpiling medical supplies and even retrieving stock from international markets back to China) has not helped matters.
Third, there will be a halt to what famous international trade economist Richard Baldwin called “the great convergence”. At least a delay and maybe even a reset. As Western world of “the North” grew rich after colonisation of “the South” causing “the great divergence”, Baldwin believes the multinational companies will allow poorer countries to take up more rich country jobs through the export of know-how and falling communication costs. So, outsourcing or offshoring could apply to professional and highly skilled jobs just as it did to call centres and manufacturing in the past. The appetite for this movement may lessen as nations respond to coronavirus and the need to keep jobs at home, even though the diffusion technology may accelerate.
Even at the height of the crisis, steel production (and demand for Australian iron ore continued) and demand for Australian agriculture will increase as overseas supply is affected by coronavirus.
Fourth, technology in some kinds of jobs in service delivery will be fast tracked. Telecommuting has been accelerated and companies such as Optus (itself a telecommunications firm) has decided employees can work from home on a permanent basis post-corona.
Fifth, what has become the “Tyranny of Social Distance” will heavily impact on trade in services. Call centres are affected (reducing possibility of outsourcing to countries such as India and the Philippines from Australia) and people-orientated businesses from the professions to hospitality, as we have already seen in aviation and tourism. While the measures are temporary, some consumers may change their preferences based on their lockdown experience.
Sixth, trends already on the way in manufacturing before the Covid-19 crisis will accelerate. And self-reliance will make a comeback for strategic reasons. Artificial intelligence (AI) and robotics have already been changing the nature of work in manufacturing, and social distancing may make robotics more attractive. Also, the flexibility of Australian manufacturing (Detmold, Gekko Systems, for example) in the crisis has shown the potential for more domestic manufacturing particularly in medical equipment and technology.
Seventh, rocks and crops will remain steady, from the mining boom to the dining boom. Even at the height of the crisis, steel production (and demand for Australian iron ore continued) and demand for Australian agriculture will increase as overseas supply is affected by coronavirus.
Eight, foreign investment will be more carefully scrutinised. Australia has relied on foreign investment since convict days and will continue to welcome it. But there will be more of a geo-political lens applied when looking at investments, where state owned enterprises are involved.
So, will coronavirus stop globalisation dead in its tracks? In the short term, it already has. But in the long term it will mean a reset not an outright rejection of globalisation especially for a trading nation like Australia.
And as citizens have turned to the national state to deal with the crisis, rather than the United Nations the European Union or (for reasons now obvious due to their conduct in the crisis) the World Heath Organisation, we will see more national building rhetoric and more policy proposals about Australian jobs and growth rather than abstract talk about international “competitiveness”, as though globalisation is a zero-sum game not a mechanism to improve the wealth of all nations together. And this is not such a bad thing. After all, as Baldwin points out, competitiveness policy is just growth policy with sexy underwear, and the national priority should be a restoration of growth and high employment levels to improve living standards in the post-corona recovery phase.
The economic impact of coronavirus has been made even more severe in oil-producing countries due to the consequences of Covid-19 itself and a collapse in oil prices. Crude has fallen below US$20 per barrel as demand for oil has plummeted. This dual shock has made it harder for oil producing countries to fight the virus.
Timor-Leste, with its oil-based economy, is no exception. To date, the Ministry of Health has confirmed 24 positive cases of Covid-19. At the same time, Timor-Leste lost about $1.8 billion in revenues from the Petroleum Fund (PF) due to the falling US stock market, where a large share of its investments are made. To prevent the virus spreading, the government instigated a State of Emergency on 28 March, putting the county under lockdown. Meanwhile, a Covid-19 Fund has been created to finance expenditure related to prevention and treatment.
Covid-19 forces us to witness what happens when a country with weak health and education systems, as well as underdeveloped agriculture and water sectors, confronts a major crisis.
As economic activity has declined as a result of the lockdown, affecting people’s livelihoods, the government has approved a socio-economic plan in a bid to provide assistance. Concrete measures include the transfer of $15 credits of electricity bills per electric meter and monetary support worth $100 per month to each household in which none of its members earns regular monthly remuneration more than $500. These are short-term interventions intended to alleviate the detrimental impacts of combating Covid-19, particularly for low-income families.
The crisis exposes the vulnerability of Timor-Leste’s economy in several ways:
If the loss of revenues from the PF continues over a longer period, any withdrawal from the fund will consist of a larger proportion of the principal than the “business as usual” case, which will further reduce the revenues generated by the fund and shorten its lifespan. This highlights two problems: a) Timor-Leste has no control over its own economy because it has no influence over global markets, and b) Timor-Leste’s ability to strengthen its economy will be weakened and the time window to diversify its economy will be much shorter if the fund decreases significantly;
The government faces a dilemma of addressing the risk of the virus spreading and trying to prevent low-income and vulnerable households from having no food to sustain themselves. This highlights the country’s widespread financial insecurity, in which the local economy cannot withstand this kind of shock when economic activities, driven mostly by the government expenditure, stop. The government therefore has to provide monetary subsidies to help those in need and to stimulate the economy; and
The country does not produce sufficient food staples, especially rice, and consequently it relies on imports. This scenario eliminates employment opportunities in the agriculture sector, particularly for people in rural areas, who otherwise could have endured this kind of crisis. Furthermore, the reliance on imported food may make monetary subsidies ineffective, especially when exporting countries have to cut food exports to provide for their own people. Thus, cash handouts should be supplemented with food and other basic needs for families to anticipate insufficient food stocks in the market.
Covid-19 has provided Timor-Leste with a stark reminder that dependence on oil revenue is economically precarious. The government has taken reasonable measures to respond to the severity of the shock by providing cash subsidies as a safety net and amplifying spending on health to mobilise health workers, as well purchasing test kits and other medical equipment. The government should see these short-term measures as an initial step towards developing investment strategies of long-term value in the social sectors. For example, the government could make health infrastructure an investment priority, such as by building first-class hospitals, to accommodate health equipment purchased during the crisis and to make the country better prepared to face a similar crisis in the future. Boosting the health sector would contribute to a stronger economy and improve the well-being of the population.
Besides the health sector, the government must also improve the productive sectors, especially agriculture and tourism, as they are pivotal to diversifying the economy and making the it less susceptible to shock. Most important of all, the government must increase investment in the education sector, which is key in every aspect of development. An educated and skilled population can open the doors to economic development through innovation and job creation.
Diversifying the economy, investing in productive sectors, and reducing dependency on oil resources are not new themes. They have been advocated by civil society organizations, development partners, academia, and even the government itself over the last two decades. However, Covid-19 forces us to witness what happens when a country with weak health and education systems, as well as underdeveloped agriculture and water sectors, confronts a major crisis.
There is no magic formula or shortcut. Support and cooperation from other countries, such as recently pledged by Australian Prime Minister Scott Morrison, are invaluable in helping to address the immediate crisis. But in the long term, it is essential to invest in these key sectors, because they are the foundation for a thriving economy. In Timor-Leste’s history, many times, it has taken a crisis to make necessary changes. Today, Covid-19 might be the crisis that can force us to change our approach to development and begin to focus on an economy driven from within, before our scarce oil money meets its end.
On 20 April 20, US oil futures closed in negative territory for the first time, implying that no one was willing to take physical delivery of some barrels of oil. While the unprecedented price moves were exacerbated by technical market operations, including an excessively large exchange traded fund (ETF) and already clogged pipelines in the United States, the real driver is lack of demand due to Covid-19 quarantines and uncertainty about how these trends will change. Longer dated futures still price in a recovery in oil prices later in the year (though less optimistically than global equity markets), but it could be a very painful adjustment to get there.
In a regional context, this raises important questions about how Asian countries might respond to and be affected by this painful adjustment – and why they may be waiting for any major energy investments.
The obvious manifestation of falling global demand is that storage capacity is filling up. Spare capacity in Cushing Oklahoma, where investors take delivery of barrels, has fallen to less than 20 million barrels according to Kpler estimates, while total capacity including the US strategic petroleum reserve is closer to 200 million barrels, levels that could be filled up in weeks. Available global storage is more ample, but it too is filling up, with at least one in ten tankers serving as a floating warehouse.
Energy market fundamentals are much worse than previous downturns, such as in 1997, when the economic shock was regional, or 2008, when financially-driven demand met constrained supply, or 2014 when US shale and relaxation of Iranian sanctions brought oversupply. Today we face what in energy markets is known as “demand destruction” of up to 30 million barrels a day less compared to April last year. This is due to twin challenges – the Covid-19 quarantines as well as the aftermath of a production spree in which neither Russia, Saudi Arabia nor the US blinked.
While a recent OPEC++ deal aims to alleviate (slowly) this oversupply, the amount of oil available will significantly outstrip demand for several quarters even as some countries begin to loosen their lockdowns. Lagging tourism, job losses, and consumer travel suggest this recovery will be slow.
And then will follow the opposite problem. Low oil prices will cause “supply destruction”, some in an uncoordinated manner, which may leave the investment and supply outlook more uncertain in the next decade.
Meanwhile, the balance sheets of oil producing nations are also much weaker. Buffers supported past stimulus measures and those countries with major foreign exchange reserves and stabilisation funds will put them to work on these very rainy days. Oil prices at or below $20/barrel (or even $40/barrel) are incredibly painful for producers, whether they be sovereigns, international oil producers, or national oil companies – or the financial investors such as private equity firms that have overinvested in the US shale patch.
With economies on life support or slowly reviving, consumption may take time to pick up and local refineries may be reluctant to increase capacity.
The upshot? This shock will reinforce existing vulnerabilities and divergencies between oil producing nations. More indebted countries will struggle to pay their bills and may need to bear the political cost of spending cuts.
The list of who is vulnerable is telling. On the corporate side, producers with higher cost resources, such as Canada and some US shale, or off-shore (Brazil), Arctic (US and Russia) are particularly exposed, but so too are countries that are over-reliant on oil and gas revenues, lack savings, or entered this crisis with pre-existing large debt and deficit positions.
Oil producers face the choice of cutting spending (which hits local stability and crimps local demand by cutting wages, and restricting government support of wages), selling assets (perhaps at a loss), or issuing debt. The shock is likely to reinforce inequality within and between producing countries. Richer, less populous jurisdictions such as Qatar and Abu Dhabi are more able to tap credit markets at affordable rates – as they have done this month. These countries, as well as Russia, have higher levels of government savings, lower fiscal deficits, and thus more leeway to adjust.
Yet countries with low oil production costs such as Saudi Arabia have high government spending bills and will likely run a deficit of $150 billion this year, drawing heavily from sovereign savings. Iraq, Algeria, Nigeria, Ecuador, as well as sanctioned Iran and Venezuela lack such savings and struggled to pay their bills when oil was $70. Even richer nations such as Oman and Bahrain are likely to need a debt workout, either regionally or from private creditors, which may force foreign and domestic policy realignments. For now, the crisis is likely to increase the dominance of governments in local economies and markets.
The fascinating question in this turbulent moment is can Asian buyers come to the rescue?
As a region of mostly oil importers, Asian countries have often taken the opportunity of crisis to renegotiate contracts, fill strategic reserves, and in China’s case invest heavily in indebted countries to ensure supply. In return they provided an increasing share of oil country’s consumer and capital imports – the domestic demand destruction among oil producers will put additional pressure on goods and construction service exports.
In a time of low prices it is rational to fill first and report later as it avoids driving up the price, however there are few signs of such buying.
China provided a financial lifeline to Venezuela and Iran, for the better part of a decade, along with major investments in Russia, Ecuador, Iraq, Sudan and Kazakhstan, although these deals may not have brought the financial returns or coercive benefits that they hoped. In 2020, we have yet to see major bulk buying or investments.
Typically, low oil prices are good for major importing nations such as China, South Korea, Japan, India, Turkey and South Africa, reducing the import bills or adding fiscal breathing space. However, with economies on life support or slowly reviving, consumption may take time to pick up and local refineries may be reluctant to increase capacity.
Indeed, efforts to boost local production may actually prompt Chinese officials to double down on electric vehicles, which would temper the increase in demand for diesel and gasoline. India, which has been a major source of new demand growth, deferred some of its oil and gas cargos due to refinery backlogs. Going forward the government may focus its scarce fiscal and credit resources on local financial lifelines and food supply. However, these countries ought to take the opportunity for some realistic new long-term contracts especially for natural gas.
Announcements about filling strategic petroleum reserves, which could help stabilise markets, are in abeyance. In a time of low prices it is rational to fill first and report later as it avoids driving up the price (as Chinese officials learned in the 2000s), however there are few signs of such buying. Countries such India would need to allocate financing for such purchases.
So watch for any investments in floating storage or partnering with oil suppliers to increase available future supplies. Building up strategic reserves could help add future resilience in this region of importers. Such arrangements with Saudi Aramco and other suppliers alleviated concerns about supply disruptions following the terrorist attack last year on Abiqaiq.
The energy transition and decarbonisation poses an additional risk in assessing the long-term financial returns of the energy sector. Decarbonisation is still in early days– major Asian utilities continue to be major investors in coal plants, but Asia’s sovereign funds may well weigh these issues when considering co-investment with energy rich countries.
Credit and operational risks may temper investments. Asian investments in sanctioned Iran have faced significant losses and operational challenges, including constraining other foreign policy objectives. While few countries share those particular challenges, a wave of debt distress and debt service relief calls may discourage new capital. China is one of the largest providers of finance to energy and commodity rich countries, via government-linked institutions such the China Development Bank, Export-Import Bank and state banks. Will they be willing to double down, especially as outward investments to Belt and Road Initiative projects had already slowed, in part due to concerns about financial exposures and foreign exchange liquidity concerns?
Meanwhile, while Federal Reserve liquidity measures have been reinstated and extended to some emerging economies, no new swap lines (RMB or otherwise) have been introduced outward from Asia. With many Asian companies seeking USD liquidity to meet repayment needs, state entities may be more choosy. Add to this a series of economic shocks that make it impossible to calculate what would be a sustainable debt burden.
There will no doubt be opportunities, especially via new partnerships, but shifting supply chains, debt distress and demand uncertainty will persist.
As the Covid-19 pandemic deepens, the need for international cooperation to deal with the twin health and economic crises has been highlighted. While much is made of the failings of the World Health Organization, other international bodies have fared no better. In particular, the G20 – which styles itself as the “premier forum for international economic cooperation” – has been largely missing in action. Comprising the world’s 20 largest economies, the G20 should be the natural forum to devise and steer the global response to the twin crises.
This is especially so given its success in responding to the previous global crisis: the 2008–09 Global Financial Crisis (GFC). Back then, the G20 was transformed from an obscure gathering of finance ministers into the main forum for crisis management, which devised a timely and effective policy response to the crisis. Its particular strength was its informal nature, which enabled networks of technocrats, officials and bureaucrats to bypass gridlocked international organisations to avert a global depression. Since then, the G20 has evolved from a crisis committee to steering committee, facilitating international cooperation on a broad array of issues, from health to development to women’s economic participation. Accordingly, the current crisis has led to widespread calls for the G20 to step up once again.
When they finally convened on 26 March, the G20 leaders promised to do “whatever it takes to overcome the pandemic”, but their communique lacked concrete commitments.
And yet, its response to date has been limited and tepid. It was largely on the sidelines early in the year, with a 7 March meeting of its Health Working Group concluding with a one-page statement with no concrete commitments or plans for action. It took calls by former leaders such as Kevin Rudd for the G20 to even acknowledge the need for a formal leaders’ summit.
When they finally convened on 26 March, the G20 leaders promised to do “whatever it takes to overcome the pandemic”, but their communique lacked concrete commitments, and their promise to inject $5 trillion into the global economy consisted of already-announced domestic measures. Moreover, there was no mention of reversing export bans of medical equipment, funding a vaccine, or addressing the economic crisis brewing in the developing world.
The roots of this failure to rise to the challenge of Covid-19 stem from both the nature of the G20 itself, and the broader international context in which it operates.
Firstly, despite its broader focus, the G20 remains at its core an institution concerned with finance. True decision-making power lies in its “Finance Track” – which brings together finance ministers, central bank governors and officials – rather than the “Sherpa Track” where all other issues are discussed. This was key to its successful response to the GFC, and also explains why its most concrete actions in the current crisis – such as the debt suspension – have been in finance, as technocrats respond to threats to financial stability. A financial focus, however, means neglect of issues such as health, which are seen as outside the purview of financial policymakers. The expansion of the G20’s remit always sat uncomfortably with the continuing centrality of the Finance Track, and has been highlighted by the current crisis.
This does not mean that the G20 lacks participation from a broader array of stakeholders. Indeed, the past decade has seen the institutionalisation of “engagement groups”, integrating civil society actors into the G20 – including NGOs, unions, women’s groups, academics and business associations – in the hope they will bring a more diverse perspectives to its agenda.
These groups have lobbied the G20 to take a holistic view of the crisis, including seriously addressing its health dimensions and going further on issues such as debt. And yet, their calls have largely fallen on deaf ears. Whilst the engagement process facilitates the participation of civil society in the G20, its terms are set by G20 officials, who often treat it as an opportunity to solicit “buy in” to their policy priorities, rather than meaningful deliberation. In this context, civil society resorts to issuing statements from the sidelines, with little effect.
The third reason for the G20’s failure stems – paradoxically – from its networked nature. Much has been made of the effectiveness of the informal institutions of the G20, in particular its ‘troika’ presidency, which brings together officials from the previous, current and future leadership countries, negating the need for a formal bureaucracy and secretariat.
As commentators have pointed out, this year’s troika was not well positioned for action, consisting of Japan, which was focused on preserving showpiece events such as Olympics, Saudi Arabia, not known for its diplomatic activism, and Italy, the European country most ravaged by the crisis. Yet the broader point is that crisis situations require action and initiative, which can only come from leaders.
This is not to suggest that their mere presence is sufficient. Indeed, the current context is characterised by populist leaders rejecting the very need for global governance and international cooperation. This populist backlash stems from the secular stagnation of the global economy since the GFC, as the underlying causes that led to the crisis – inequality, stagnating wages and social mobility and growing precarity – remain unaddressed. The G20 is not free from responsibility for this, struggling since 2010 to devise meaningful solutions. As a result, confidence in the efficacy of international cooperation has declined further, with the G20 largely gridlocked along North-South lines. In this context, it’s not surprising that the response from G20 leaders has been to further pull up the drawbridges and engage in beggar-thy-neighbour policies.
In short, the G20’s failure “to demonstrate the power of global cooperation” stems both from its own nature and the broader international context. There seems little hope for a sudden change of course, either for an effective response to the health crisis or a bold new agenda to address the economic crisis, even before the “Great Lockdown”.
“This is a moment of reconstruction – we need to reinvent ourselves, myself included,” declared French President Emmanuel Macron in a televised address last week, during which he extended the country’s partial lockdown until 11 May.
Macron spoke of the need to reach strategic autonomy in the sectors of agriculture, health care, industry and technology – but stopped short of detailing such a new strategy.
Close observers and analysts are still grappling with the changes. The views of various experts are instructive about the range of possibilities.
France and other European countries have been spending billions of euros in subsidies and government loans to get their companies and workers through what is shaping as the biggest economic crisis at least since the Second World War. Private airlines in Germany, France, and Italy could be partly nationalised. Spain is considering introducing an unconditional basic income.
For now, only short-term fixes have been implemented. But could this crisis lead to a more profound economic rethink, away from the current market-orientated dogma, such as hinted at in Macron’s speech? Or could it be even more?
Close observers and analysts are still grappling with the changes. The views of various experts are instructive about the range of possibilities.
Philippe Marlière, a Professor for French and European Politics at University College London, doubts a shift in market policy:
European leaders will of course invest more in certain sectors – our health care services, renowned to be the best in the world, failed in so many ways as they were lacking capacity and protective gear.
Indeed, several countries will from now on produce their own face masks and respirators. “But that won’t call into question the underlying economic strategy,” Marlière claimed.
It will be selective interventionism and like after the global economic crisis in 2008: governments won’t make structural changes – instead, workers will have to foot the bill, for example through longer working hours.
Bruno Cautrès from the Paris-based Centre for Political Research CEVIPOF shares Marlière’s scepticism. “Macron has been defending his market-orientated reforms and globalisation for three years – how could he possibly now maintain the contrary?” Cautrès said that Macron’s announcements had so far been very vague, and doubts other EU governments would perform policy U-turns. “Otherwise, they would lose all their political capital,” he said.
But Rémy Oudghiri, sociologist and head of Paris-based consultancy Sociovision, thinks the pressure on Macron is mounting. “This crisis has shown that our open, market-orientated economy is very fragile,” Oudghiri said. If adding, the Covid-19 crisis had further fuelled growing resentment against Macron’s austerity politics. As Oudghiri put it:
The French are attached to their public services and a strong state. They don’t adhere to globalisation in its current form and want to return to a form of economic sovereignty.
Some economic historians would agree with Oudghiri – and it’s not only France. Historians compare the Covid-19 crisis to the wartime effects, with the economy collapsing and unemployment skyrocketing.
Dominique Barjot, Professor of Economic History at Paris Sorbonne University, says that such economic shocks trigger a so-called ratchet effect. “Once you put in place certain policies, you can only partly take them back,” he said.
Barjot predicts the return of France’s “Etat Providence”, the strong welfare state with a strategic economic role that developed after 1945.
We have realised that we need to take control again of crucial sectors such as health care, energy, transport and even the textile industry – we can’t keep on depending on other countries for everything.
He also thinks that the state will also play a bigger role in other countries, albeit to a lesser extent.
Albert Ritschl, Professor of Economic History at the London School of Economics, adds that the ratchet effect will equally have implications in other areas.
Opposition forces and unions will gain in power, as they need to be brought in to get through the crisis … All this means the balance of power will shift away from the market towards the state – even though the basic rules of our market economies haven’t changed.
Niclas Frederic Poitiers, trade economist and research fellow at Brussels-based economic think tank Bruegel, is wary that such a stronger state will further undermine free trade.
“The crisis will give momentum to protectionism, which is already on the rise, especially since US President Donald Trump was elected,” Poitiers said. “But this will come at a price for the consumer – producing more at home instead of in countries where production is cheaper means prices will go up.”
And the corona shock could also hit economic thinking on a company level.
“The crisis has made companies realise to what extent their global supply chains are fragile,” according to Andreas Wieland, Associate Professor of Supply Chain Risk Management at Denmark’s Copenhagen Business School.
Businesses will now diversify their ways of supply and source certain pieces at least in several Asian countries and not just in China … Some might even create redundant supply chains at home to be fired up in times of crises.
But Wieland doubts the crisis will mean the end for global supply chains.
Companies won’t suddenly switch to circular supply chains as it would be too much of a radical change – although this would end their dependency on raw materials from abroad as the latter would no longer be wasted.
To what extent the Covid-19 crisis will change the rules of the game won’t be clear before at least several months. Macron, meanwhile, has said in recent days that despite the first instinct of nations to look after themselves, “I believe it is a chance for multilateralism”. He has promised to give more details on his economic reinvention in weeks ahead.
Oil made headlines around the world again today, with US oil prices falling below zero for the first time. So what does it mean?
Three perspectives can help to make sense of the headlines.
First, from an economic perspective it’s quite simple – the supply of oil has outstripped demand and prices have fallen accordingly. As Covid-19 has brought the global economy to a standstill, with planes sitting on runways and cars idle in the garage, demand for oil has plunged.
But it is not easy for oil producers to turn off the tap, so they need somewhere to store it until they can find a buyer. The problem is there is very little storage left so producers are literally paying buyers to take it off their hands, hence the negative prices we witnessed today in the US. But don’t expect to be paid instead the next time you fill up your car at the petrol station – as explained here.
Sustained low oil prices threatens to send some US shale producers to the wall, which could hamper the US oil sector and limit the geopolitical leverage of the United States.
However, if we view oil from a security lens, the picture looks quite different. For many nations energy security has been defined in terms of access to reliable and affordable oil and gas. So low prices are generally good for big consumers, such as China, and bad for big producers such as Saudi Arabia, or more lately the United States.
Security scholars have argued that the US shale revolution – the technology breakthroughs that have allowed producers to access the vast onshore oil and gas reserves and turn the US into the largest producer in the world – will boost American power and transform energy politics in Europe, Asia, and the Middle East to America’s advantage.
However, sustained low oil prices threatens to send some US shale producers to the wall, which could hamper the US oil sector and limit the geopolitical leverage of the US in these regions – although Donald Trump is doing a pretty good job of that himself.
Finally, rather than focussing on markets as economists do, or energy security as security scholars do, we can also ask an entirely different question: who is governing global oil markets? This is an important one because it draws our attention to the various international organisations and multinational oil companies that also govern oil at the global level.
For example, two weeks ago we saw the G20 – the informal forum of world leaders of which Australia is a member, and which coincidentally is hosted by Saudi Arabia this year – establish a short-term “Focus Group” on the issue, calling upon international energy organisations, such as the International Energy Agency, to help stabilise global oil markets.
Which organisations dominate this process, and how effective they prove to be, for example, in brokering agreements between producers and consumers could play a big role in determining the oil outlook over the coming months.
Predicting future oil prices is a mug’s game but one thing is for sure – the consequences of what is taking place are never as simple as one perspective would have you believe.
What impact will coronavirus have on economic globalisation, the force that has so momentously changed our world over the last half century?
An early example is the global trade in medicines and medical products, especially those essential to fighting coronavirus such as face masks, ventilators and test kits. As the US Congressional Research Service (CRS) observed in an 6 April note, Covid-19 “is drawing attention to the ways in which the US economy depends on manufacturing and supply chains based in China”. White House trade adviser Peter Navarro said last month he is preparing an executive order to help relocate medical supply chains from overseas to the United States. Japan has already announced such a plan. Australian Industry Minister Karen Andrews has also joined in, foreshadowing a review of Australia’s reliance on imports of medical products.
Although this is shaping up as an interesting debate, facts may intrude.
One fact is that the global trade in medical products is mostly an advanced economy business. The US itself is a very big exporter of medical equipment and pharmaceuticals. On US Bureau of the Census numbers exports in these two categories last year totalled nearly $100 billion, putting the US just behind Germany as the second biggest global exporter of medical products.
On recent World Trade Organisation numbers, the top six exporters of medical products are Germany, the US, Switzerland, the Netherlands, Belgium and Ireland.
Germany and the US are not only the top exporters but also the biggest importers – and in each case their top suppliers are other Western democracies.
Using those same WTO numbers, all of China’s exports of medical products last year totalled just one 20th of world medical exports, way behind Germany with one seventh, or the US with one eighth.
Policies that injure global trade in medical products would hurt the US and its Western democratic allies more than most, and in a sector well suited to their strengths in technology and intellectual property.
A lesson of the pandemic is certainly that no nation can rely on imports to meet its needs when every nation on earth suddenly wants the same products.
The US Bureau of the Census numbers for trade in pharmaceuticals and medical equipment show the US sells more to China than China to the US. Using a wider category the WTO shows a “medical products” bilateral imbalance in China favour but also shows that while the US accounts for nearly a fifth of China’s imports of medical products, China accounts for less than a 10th of US imports of medical products.
US medical products imports from Ireland, Switzerland and Germany are worth nearly five times US medical products imports from China.
Another intrusive fact is that China is only an important supplier of medicines and medical equipment to the US and the rest of the world in a couple of areas.
Coronavirus testing kits were in short supply in the US (and elsewhere). But China had not been an important exporter of these kits and on the CRS numbers accounted last year for only a tiny share of US imports.
Respirators are another essential piece of coronavirus treatment equipment, but China is not a big exporter to the US. According to the CRS, China accounted for 17% of US imports of respirators, much less than Singapore.
China produces some important active pharmaceutical ingredients (APIs) used by US drug makers, but its most important medical export to the US is face masks and other personal protective equipment (PPE). On CRS numbers China accounts for 72% of US imports of textile face masks, 77% of imports of plastic gloves, and half of imports of protective garments.
Though China restricted exports of face masks in early January, when China’s own requirements were huge, it resumed exports in February. Since 1 March, according to China’s customs service, it has exported 26.7 million N-95/KN-95 masks, 504.8 million surgical masks, 195.9 million gloves, 17.3 million surgical gowns, 873,000 goggles, 3,253 non-invasive ventilators and 112 invasive ventilators.
In the categories where it accounts for significant shares of US medical imports, China does not appear to be responsible for shortages. In a 27 February press release addressing issues in medical supplies US Food and Drug Administration Commissioner Stephen Hahn told the media that no US firms importing drugs or active drug ingredients from China reported shortages, and the drugs in question were anyway regarded as “non-critical” for coronavirus treatment. The FDA had contacted US manufacturers producing “essential” medical devices in China. Hahn told the media ‘there are currently no reported shortages’ for these medical devices. In respect of masks, gowns, gloves or other PPE, Hahn told reporters the FDA “is currently not aware of specific widespread shortages”.
So what lessons on globalisation and medical products can we draw from the pandemic?
One is that normal production of medical products will never be enough to meet the extraordinary demands of a pandemic, whether the production is at home or abroad.
Surgical face mask production is a good case in point. Despite China producing half the world’s face masks last year, its output proved nowhere near enough for a population the size of China’s during an virulent epidemic. At the high point, according to the Organisation for Economic Cooperation and Development, China was using 240 million masks a day – more than ten times its manufacturing capacity. It cut off exports, imported masks, and increased domestic production from 20 million masks a day before the crisis to 116 million a day at the end of February. Taiwan, South Korea and India also restricted mask exports (including to China), for much the same reasons.
A lesson of the pandemic is certainly that no nation can rely on imports to meet its needs when every nation on earth suddenly wants the same products, and in vast quantities. At various times and to varying degrees, 60 nations restricted exports of medical products during the pandemic.
But another lesson is that nations cannot routinely produce within their borders the volume of medical equipment and pharmaceuticals needed for a pandemic. It is not a practical possibility for any nation or the entire global economy to produce every year the volume of output that might be needed one year in 20. Instead, the lesson is that every nation needs to stockpile enough essential supplies to get it through to the point where imports in sufficient quantity and emergency domestic production are available.
In the US and elsewhere the level of stockpiling was insufficient. The US Health and Human Services reported earlier this year that the US stockpile of face masks was less than 1% of what would be needed for a year-long epidemic. The face masks stockpile in China was clearly insufficient.
Even so, shortages of medical products do not account for the severity of the epidemic in Lombardy or New York. More testing and therefore more testing kits would have helped, but the great difference could have been made by earlier action to reduce infections, including lockdowns, social distancing, and travel bans.
Confronted by the coronavirus pandemic as a “black swan” event, most countries have chosen the hard suppression strategy with variably stringent lockdown measures. This is based on modelling that shows a dramatic shortage of intensive care beds and ventilators and other crucial medical equipment to treat the numbers afflicted under worst-case scenarios. Panicked by the prospect of health systems being overwhelmed and millions dropping like flies as in the 1918 “Spanish flu” pandemic, they have shuttered entire economies and populations.
While this is understandable in conditions of extreme uncertainty with a novel virus, there should have been more caution because of a history of failed catastrophist warnings, the massive economic costs which also have deadly impacts, the draconian infringement on individual freedoms, and the availability of other strategies rather than the mythical “do nothing” alternative.
Health professionals are duty-bound to map the best- and worst-case scenarios. Governments bear the responsibility to balance health, economic, and social policies. Once these are included in the decision calculus, the political and ethical justification for the hard suppression strategy is less obvious.
Lockdowns slow the peaking and help to ensure an even distribution of cases, but may not reduce the final numbers significantly.
First, there are many “known unknowns” about the coronavirus: the true infection- and case-fatality rates; the variable reliability of statistics from different countries that are not always measuring the same things with a standardised methodology; the risks of (re)infection rates as social-distancing restrictions are lifted, and more.
In a seriesofarticles in The Spectator, John Lee, a recently-retired Professor of Pathology and consultant to Britain’s National Health Service, discusses the non-comparable ways in which coronavirus infections and deaths are recorded in different countries, and the relative mortality rates of flu and coronavirus. He is highly critical of the modelling to date used as the basis of current UK policy. Teams from Oxford and Stanford mapped a range of different outcomes using different assumptions.
Because of the acceleration with which the initial surge in infections comes, governments have been worried that without control measures, they will not have time to react and hence have implemented preventive lockdowns. Better safe than sorry is a good prudential policy. Yet we also lack reliable data about the retransmission rate. High levels of testing means more policy options for social mobility and economic reopening. If the average number of new cases generated by a single infected individual is above one, an outbreak spreads, but contracts below one. The challenge becomes to keep the combined new infections and retransmission rates constant or falling, rather than exponential and explosive. By mid-April Asian countries were fearing a second wave of infections and on Thursday Japan declared a nationwide state of emergency to suppress the virus. A gentle exit strategy will be accompanied by an intensive “test, trace and isolate” regime to detect and kill new outbreaks.
Second, catastrophism on previous epidemics proved false. In 1999, European Union scientists suggested up to 500,000 people could die from the UK mad cow disease. By October 2013, 177 deaths were recorded from the disease. In 2005, the UN’s coordinator David Nabarro warned between 5 to 150 million people could die from avian flu. The World Health Organization’s official estimates were 2–7.4 million. Only 455 people died of bird flu from 2003–2019.
With the 2009 swine flu, instead of the feared 1.3% fatality rate, the actual rate was 0.02%, comparable to the US 2007–09 seasonal flus. In the UK, against the “reasonable worst-case scenario” of 65,000 deaths, there were only 457. And the government spent £1.2bn on flu remedies that were not needed. The WHO came under severe criticism for having served the interests of “Big Pharma” in selling unnecessary vaccines.
UK fatality estimates for Covid-19 were scaled down dramatically by Imperial College London within two weeks, from 510,000 to 20,000 and then 5,700, of whom up to two-thirds would have died from comorbidities within one year anyway. On 12 April the UK was reported as having crossed the 10,000 mark in numbers killed. But this is misleading for, like Italy, the UK records someone dying with virus as dying of it: patients who “had tested positive for Covid-19 at time of death.” By contrast, Germany attributes the deaths to the comorbidity. In Italy, one study estimates that only 12% of attributed deaths are in fact caused by Covid-19. The Financial Times helpfully explores this issue in an article “The mystery of the true coronavirus death rate.”
Grave and prolonged economic damage takes its own tragic toll on lost livelihoods and lives.
The Financial Times had another interesting analysis of whether the UK government has been captured by epidemiologists over other experts, treating them like demigods. At least 22 experts have questioned the high casualty projections of the dominant models. The high-end estimates have so far proven to be exaggerated. According to the Institute for Health Metrics and Evaluation at the University of Washington, the projected US Covid-19 death toll by 4 August will be 68,841 (within the much wider range of 30,000–176,000). The actual estimated death as at 12 April was just short of 22,000.
To put this in perspective, according to the National Center for Health Statistics, the annual fatality toll from flu and pneumonia in 2017 was 55,672 and from diabetes another 83,564. Australia recorded 158,493 deaths in total in 2018 from all causes. In the 45 days from Australia’s first Covid-19 death on 1 March to 63 deaths on 16 April, around 19,500 Australians would have died from all causes, but there was no daily chart on the front page of the newspapers recording the mounting toll every day. Against Australia’s maximum capacity of 6,636 beds, on 15 April there were just 214 coronavirus patients in hospital, with 76 in an intensive care unit.
Third, at some point the cure becomes worse than the disease. The harshness has been justified as prioritising lives over jobs. But “flattening the epidemic curve” comes at the cost of flattening economies. A spate of reports from Goldman Sachs, the International Labour Organization, International Monetary Fund, Oxfam, World Bank, and World Trade Organization warn of dramatic decelerations and contractions in GDP and trade from the pre-pandemic forecasts, with a resulting ballooning of poverty with job losses and income falls. The IMF’s World Economic Outlook forecasts the global economy will shed around $9 trillion in 2020. In the “Great Lockdown”, world output will contract by 3%, hitting both advanced and emerging economies simultaneously for the first time, and cause steep rises in unemployment, debt and bankruptcies.
Grave and prolonged economic damage takes its own tragic toll on lost livelihoods and lives. This is seen at its most acute and more immediately in developing countries whose people “fear hunger may kill us before coronavirus”.
However, advanced economies are not immune. The UK has recorded a sharp rise in the number of people dying at home, including from cardiac arrests, because people are reluctant to call for an ambulance. They fear that beds may not be available, or that they might contract the virus in hospital. Because an efficient and universal-access health system operates inside a robust and resilient economy, decreased wealth will inevitably lead to degraded public health infrastructure and a resulting loss of life. Most elective surgery is postponed while hospital beds lie idle awaiting coronavirus patients. An article in Lancet Psychiatry says Covid-19 could have “profound and pervasive impact on mental health” caused by loneliness and anxiety. A 2014 US study found a 1% rise in the unemployment rate elevates the risk of dying next year by 6%. On 16 April the US Department of Labor reported that unemployment claims had risen by more than 20 million over the previous four weeks, around the number of jobs added over the past decade. The lockdown also puts women at much greater risk of domestic violence.
Many heroic assumptions are also being made: about the capacity of national governments to contain short-term damage and revive the economy from induced coma in the medium term; about the Trump administration’s skill in managing the economic and trade fallout; and about the limited global damage from economic downturns in China, Europe, and US.
Fourth, asserting state control over swathes of economic activities is not the only curtailment of freedoms. The extreme measures of quarantining entire populations also constitute de facto mass house arrests. The physical, mental and emotional health benefits of open-air exercise are universally acknowledged. A court in Germany has reversed a regional government’s ban on people going to the beach as a disproportionate curb on freedoms. In a BBC interview on 31 March, former UK Supreme Court Justice Lord Sumption warned:
when human societies lose their freedom, it’s not usually because tyrants have taken it away. It’s usually because people willingly surrender their freedom in return for protection against some external threat.
We have both the right and a duty as citizens to be vigilant against government over-reach. Democratic accountability generally improves public policy outcomes.
Fifth, Europe and the US have been less successful in their interventions than the East Asian states, which have mostly avoided generalised hard lockdowns. As at 15 April, without lockdowns, Japan (1.2 coronavirus deaths per million people/146 total deaths), South Korea (4.3/225), Singapore (1.8/10), and Taiwan (0.3/6) have far lower death rates than Spain (397.6/18,579), Italy (358.2/21,645), France (256.3/17,167), and UK (193.5/12,868) with lockdown.
Lockdowns slow the peaking and help to ensure an even distribution of cases, but may not reduce the final numbers significantly. Anthony Costello of University College London claims alternative public health measures such as identification of cases and contact tracing could have softened the lockdown. Rigorous social distancing has shut down large parts of the economy and also left the UK vulnerable to a recurrence of the disease when restrictions are lifted because few people will have acquired immunity.
Indiscriminate shutdowns require the least and most vulnerable – the young and fit versus the elderly and infirm – to shoulder equally the risk of the virus spreading. The fatality rates in the big congested regions such as London, New York City, and New Jersey are the worst affected. And overwhelmingly the elderly and people with existing comorbidities are the most at risk. Yale University’s David L. Katz advocates a “vertical interdiction” strategy to target those most at risk. In some locations the toll has been grim indeed. In Canada half the deaths have been in aged care homes. New York, with many traits the opposite of Australia’s, was initially too casual about the virus and in the second week of April it resorted to mass burials. A strategy that makes sense for the biggest and most densely packed cities may be less appropriate elsewhere.
Australia’s low toll is better explained by physical isolation, vast open spaces, low density living, few multigenerational households, high use of private cars instead of mass transit, and sociocultural practices.
In the months and years ahead, Australia should learn from the stunning example of Taiwan in thwarting the spread of coronavirus but managing to avoid mass economic and social disruptions by using big data and analytics. Taiwan lies just 130 kilometres offshore from China, has 1.2 million people living or working there, and 3–4 million travel between the two territories annually. Yet Taiwan gained the upper hand with early and aggressive interventions through widespread and efficient testing, strictly isolating suspected cases, diligently tracing the movements of others who had been in contact with infected people through their mobile phones, and tight control at air and sea ports of entry.
Australia’s collateral costs could have been reduced and the health outcomes might not have been dissimilar with a policy of early checks at air and sea ports of entry by mid-February; isolating the elderly, infirm and vulnerable; quarantining the infected with serious symptoms; putting in place testing facilities at office complexes, shopping malls and other crowded public spaces; and leaving individuals responsible for personal hygiene and social-distancing precautions.
On the far side of the pandemic, Australia may want to rebuild a national health service without a parallel system of private health insurance schemes and hospitals. This will facilitate the creation of a national health emergency response unit, in coordination with states, to exploit big data and analytics and connect the health, pharmaceutical, customs and immigration records, trace people’s 14 day overseas travel history, and link them to mobile apps to monitor their in-country movements with appropriate safeguards, along with oversight mechanisms to meet privacy concerns.
In this episode of COVIDcast, Roland Rajah sat down with the Institute’s Director of Research Alex Oliver to discuss the impact of the coronavirus on the global economy. Roland is Director of the International Economy Program and Lowy’s lead international economist.
One of the key questions about the economic impact of Covid-19 is whether the shock will be temporary or longer-lasting. Rajah explains in this episode why he believes the economic shock will permanently change the global economy, at least in some respects. Looking at the International Monetary Fund forecasts released this week, he notes that even under the IMF's “rosy outlook”, by the end of 2021 “the global economy will already have lost at least $5 trillion”, the equivalent of missing an economy the size of Japan’s. Under the IMF’s more negative scenarios, by the end of 2021 the world would be “missing an economy almost the size of the entire US”.
Each week since the severity of the coronavirus crisis became clear, Lowy Institute experts have been sitting down to discuss the implications of coronavirus for Australia, the Asia-Pacific region, and the world. Episodes one to six are already online, and this is the seventh instalment in the series, which we’ll be continuing on a weekly basis as this crisis unfolds.
Among other issues Oliver and Rajah discussed were the G20 finance action plan announced this week, and the economic plight of developing and emerging nations. According to Rajah, the virus has inflicted a “violent and unprecedented withdrawal of funds from these countries”. He outlines a proposal made on The Interpreter this week that Australia should extend a significant loan to Indonesia, to boost market confidence and help address the financial shocks it is experiencing.
Amid speculation that China will exploit the crisis to its own advantage by providing economic aid to emerging countries, Rajah points out the limits China will face in doing so and that China will only gain the upper hand if other countries don’t also step up in ways that they can, and should.
COVIDcast is a weekly pop-up podcast hosted by Lowy Institute experts to discuss the implications of COVID-19 for Australia, the Asia-Pacific region, and the world. Previous episodes are available on the Lowy Institute website. You can also subscribe to COVIDcast on Apple Podcasts, listen on SoundCloud, Spotify, Google podcasts, or wherever you get your podcasts.
There is a growing recognition that Australia will need to do a lot to help the Pacific get through the Covid-19 pandemic. Like everywhere, big sums of money are needed. The question is how to finance it.
Many advanced economies are rolling out budget packages of 10% of GDP or more. The Pacific might need something similar. If so, that could mean as much as A$5 billion.
For the aid dependent Pacific, funding at anywhere near this scale must come from outside. Though other development partners will need to contribute, Australia is by far the leading player in the region. So there is some expectation that Canberra will have to do a lot of the heavy lifting.
For nine Pacific countries, sizeable Covid loans combined with policy dialogue around how future government spending and development partner assistance might be adjusted seem a reasonable path forward.
Given Australia’s own budgetary pressures, consideration has naturally gravitated towards the idea that much of this may have to take the form of loans rather than grants. Yet, that sits awkwardly with the repeated warnings issued by many – including by the authors of this article, as well as the Australian government – about the mounting risk of debt overload in the Pacific.
Can a big round of Covid loans really be justified, especially at the scale that might be required?
Concerns about debt overload usually focus on the debt sustainability analysis (DSA) ratings produced by the International Monetary Fund (IMF) and World Bank. These DSAs generally point to very limited room for the Pacific to absorb significantly more debt, with many countries already judged to be at a high risk of debt distress (see the table below).
However, mechanically applying the existing DSA ratings is not the best guide to thinking about how to finance today's pandemic response. The DSAs are based on a host of assumptions that will now need substantial revisiting, most notably about the scale and nature of future government borrowing plans. Clearly, with the current situation facing the region – which also includes a major tropical cyclone which hit Vanuatu, Fiji, and Tonga – financing needs and priorities will be substantially reshaped. Like their rich country counterparts, Pacific governments will need to keep their economies (and societies) afloat today, even if this might come at the expense of spending plans for tomorrow.
Updated DSAs will be required. But policy decisions are moving fast. In a crisis, there is no other choice.
DSA rating *
Total public debt risk indicator
External public debt risk indicator
Papua New Guinea
* Most recent IMF and World Bank Debt Sustainability Analyses (as of 07/04/2020) ** For Fiji, Palau, and Nauru, the IMF uses a ratings system for higher-income countries where it simply rates their debt outlook as “sustainable” or “unsustainable”. While Fiji and Palau are rated as sustainable the DSAs make clear there is limited room for additional debt.
To provide some immediate guidance, we conducted a simple exercise to examine the implications of a large package of hypothetical Covid loans against two key debt sustainability warning indicators.
The first focuses on the size of public and publicly guaranteed debt as a share of GDP. The second is the same measure but focused only on that owed to external creditors. In both cases, we use “present value” measures that account for how concessional or expensive each country’s existing debt is on average. We then add 10% of GDP in Covid loans – adjusting for the fact that we expect these would be provided on at least a semi-concessional basis (broadly following the loan terms under Australia’s Pacific infrastructure financing facility). We then compare what would result from a one-off round of Covid loans for each country against the warning thresholds used by the IMF and World Bank in their DSAs. Note, we make no adjustment for reduced economic growth as this remains uncertain and in only a few cases would this likely be large enough to sway the picture presented here.
The chart below shows the result for the total public debt indicator, while the overall results are summarized in the table presented above, along with the existing DSA ratings.
While having its limitations, the exercise suggests that five of the nine Pacific countries for which data is available would not immediately breach either of the warning thresholds. For these countries, sizeable Covid loans combined with policy dialogue around how future government spending and development partner assistance might be adjusted seem a reasonable path forward.
Conversely, two microstates – Marshall Islands and Tuvalu – do not appear to have scope for large Covid loans. For these two, the Covid financing response will need to take the form of grants.
Finally, Papua New Guinea and Tonga present a mixed picture, with each breaching one of the two warning thresholds. The breaches are however small, implying either more concessional or smaller loans could still be feasible. A more careful approach will nonetheless be needed in these countries given their heightened risk as well as to account for the negative growth impact of the virus. In the case of PNG, for instance, a formal structural adjustment program already looks likely to be a key part of any Covid bail-out package.
Clearly, there are more sustainable ways to finance the pandemic response from a Pacific perspective – using more concessional financing and combining this with debt restructuring or even outright forgiveness. Hopefully these will also be part of the overall pandemic response. The multilateral development banks are for instance preparing concessional financing packages, while on Wednesday night, the G20 has agreed to an eight month standstill on debt repayments to bilateral creditors – an approach that could benefit some Pacific countries, on the condition they are currently on debt service to the International Monetary Fund or the World Bank.
Nonetheless, the perfect should not be the enemy of the good. The scale of the current crisis means large Covid loans may need to be part of the answer. Fortunately, there is at least some scope to do this sustainably.
The Morrison government needs to urgently consider how it might best help Indonesia manage the economic risks posed by the Covid-19 pandemic. Indonesia faces a perilous outlook. The government is struggling badly to control the virus. Making matters far worse, Indonesia has also been among the hardest hit by the violent rush of money surging out of emerging economies worldwide.
What happens in Indonesia is of special importance to Australia given its size, proximity, and general centrality to our economic, diplomatic, and security interests. Australia should do what it can to help.
Indonesia’s huge size – 270 million people and a trillion-dollar economy – might make it seem impossible to offer meaningful help without this being at such great cost as to be politically infeasible. Especially as Australia’s economy is itself taking a battering from the virus.
Yet, Australian support could make a significant difference and, if structured properly, at little to no cost to the Australian budget.
Specifically, the Australian government could provide the Indonesian government with a sizeable “standby” loan facility – as much as US$10 billion (A$16.1 billion) – that could be drawn upon if Indonesia ran into difficulty raising adequate budget financing from the market. This could be complemented by also extending a currency swap line – perhaps for another US$10 billion – to bolster Indonesia’s defences against excessive currency depreciation, as recently suggested by former Indonesian finance minister Chatib Basri and economists at the Australian National University.
The beauty is that neither arrangement would need to be drawn upon to have a positive insurance effect. Their mere existence would serve to boost market confidence that Indonesia will be able to finance its budget deficit and withstand unwarranted currency pressures, making it less likely that the facilities would be called upon in the first place.
Unfortunately, it is easy to see how a perverse feedback loop might form, with market fears limiting the ability of policymakers to respond effectively, thereby increasing the damage from the virus, prompting more capital outflows, and so on.
Australia has participated in similar standby loan facilities for Indonesia in the past – in 2009 during the global financial crisis, and again in response to the 2013 “taper tantrum”. On both occasions, Australia committed about A$1 billion, that was never drawn upon, as part of a roughly US$5 billion multilateral facility led by the World Bank.
Today’s crisis clearly requires a far larger sum. Yet, the huge pressures on Australia’s own budget risks complicating the politics. To overcome this, a key difference this time around could be to anchor the loan terms close to Indonesia’s own sovereign borrowing costs during “normal” times, instead of providing a semi-concessional loan as in the past. The currency swap could take a similar approach.
Indonesia does not need a modest amount of cheap financing. What it needs is to be able to borrow at normal market rates but with certainty and at scale. Crucially, for Australia this means that, even if the funds were called upon, it would not impact negatively on the underlying cash balance nor fiscal balance of the Australian budget – as the lending terms could be priced for any risk of default.
To see why such support could be pivotal, it is critical to recognise that Indonesia’s reliance on unstable foreign financing threatens to greatly exacerbate the damage from the virus pandemic.
Indonesia has already suffered around US$10 billion in financial outflows since late January while its currency has plummeted 14%. A sizeable US$410 billion in external debt, owed mostly in US dollars, make this a big problem. Evaporating commodity export demand compounds the difficulties.
Outflow pressures have eased in the last few days. But these could easily return with even greater force – especially if problems in other emerging economies were to spark fears of financial contagion or if Indonesia lost control of its own domestic virus situation.
Equally worrying is if a reliance on unstable foreign financing were to prevent Indonesia from deploying the kind of massive fiscal and monetary expansions needed in all countries to keep the economy (and society) afloat through the pandemic. Worse, Indonesia’s government might be deterred from pursuing adequate public health measures if it fears it would be unable to deliver the policy support needed to mitigate the economic and social fallout that would directly result.
One can already see signs of all this. Indonesia’s economic policy response to the virus has been relatively timid – with new budget measures worth just 2.8% of GDP and interest rates only cut to 4.5% to avoid putting further pressure on the currency. The central government has also only reluctantly begun to slowly roll out enforced social distancing measures.
Far more might be needed on both the health and economic fronts. The question is whether market conditions will allow it. Unfortunately, it is easy to see how a perverse feedback loop might form instead, with market fears limiting the ability of policymakers to respond effectively, thereby increasing the damage from the virus, prompting more capital outflows, and so on. Whatever happens with the virus itself, such a vicious cycle threatens to make things far worse.
Fortunately, Indonesia’s economic fundamentals are sufficiently healthy that, with some additional support, it could be in a good position to withstand the economic pandemic unleashed by the virus. The Australian policy support suggested here, combined with realistic contributions from other governments and multilateral institutions, could make that difference.
If Indonesia is interested in taking out such crisis insurance, Australia should willingly oblige.
As borders close and globalisation contracts, consider the impact on the Pacific Island neighbours. Many countries in the region rely on labour mobility, with workers sent to Australian and New Zealand to help with fruit picking and work in regional areas. Workers on these schemes send around A$9,000 back to their families, the equivalent of three years wages in many countries.
Remittances such as these are vital to support countries with limited domestic industry. In Samoa, remittances make up around 18% of GDP, the equivalent of the manufacturing, agriculture, and mining industries combined for Australia. In Tonga, where remittances makes up 40% of GDP, the Australian seasonal work program alone is larger than aid plus trade.
Labour mobility is managed under the aid program and considered a win-win for Australian and New Zealand businesses struggling to have reliable seasonal employment. It provides greater agency to the most aid-dependent region in the world.
These programs were conceived in a world where Pacific Islanders could fly from their homes to Australia and New Zealand. Covid-19 has changed that world, at least for the short-term.
Countries all across the Pacific have declared a state of emergency, some lasting months. Flights have practically ceased. This slow-down greatly affects Pacific countries reliant on imports, tourism, and revenue from labour mobility.
The Australian government has responded, announcing on it would extend visas for Pacific Islanders already working on labour mobility programs by up to 12 months. New Zealand has extended temporary visas to late September. These arrangements will be a bonus for employers, enabling them to cover the next harvesting season and maintain experienced workers.
Both countries have barred all visa holders and hence future workers from entry. Pacific countries are also reluctant to send workers until it is safe to do so.
Extra income from extended visas will be welcomed by many workers. Interviews with returned workers in Samoa last month found many appreciated opportunities for extended deployments so they could send more money back to their families. Unsurprisingly, families of workers are worried about safety for those in countries with higher rates of Covid-19 than at home.
Horticulture work is physically exhausting and there is the very real risk of injury or illness restricting the ability for workers to continue indefinitely. Care must also be taken to ensure workers are still looked after and have sufficient income if they contract Covid-19.
If businesses stop operating, workers will be in the position where they are ineligible for welfare and unable to return home. This may be inevitable for hospitality workers in remote areas.
For businesses that continue operating, as many horticulture businesses should, there are practical challenges: colder weather and relocation to other farms. Workers are uncertain when they will be able to see their families again.
Vulnerable workers are at risk of exploitation, underpay, and modern slavery conditions. Given recent levels of uncertainty and the lack of other options, workers are particularly susceptible. Workers, their families and Pacific governments need greater transparency about health insurance coverage, worker obligations to particular employers, and what support and care is available in uncertain times.
If businesses stop operating, workers will be in the position where they are ineligible for welfare and unable to return home. This may be inevitable for hospitality workers in remote areas.
Pacific leaders met remotely on last week to discuss responses to Covid-19, with the Secretary General of the Pacific Islands Forum proclaiming: “If ever there was a time where the region and its partners needed to work together… it is now.”
Australia and China are providing resources to scale up health facilities, but as even the wealthiest of countries are struggling, greater support may be required. The economic implications of this crisis are still being understood, and it will undoubtedly ripple across the Pacific where many countries are in lockdown.
Labour mobility can complement these packages, getting cash into people’s hands. A practical way to assist is to support workers with sending money back to their families right now when it’s most needed. Before the current crisis, nearly two-thirds of the money sent back from workers was once they’ve returned either from cash or ATM withdrawals at the airport.
There is already evidence that less money is flowing back to workers’ families. Financial services in Samoa have warned there is a significant drop in remittances received since the Covid-19 outbreak. Local families are either going without or relying on credit from village retail shops until they receive money again.
The service provided by Australia and New Zealand to assist in sending money back needs a more personalised approach. Workers have limited online financial literacy and, in many cases, limited English. Those in horticulture have restricted movement in New Zealand and are often in remote areas of Australia.
Governments need to explore safe ways with reasonable precautions to continue bringing Pacific Islanders to work particularly in horticulture throughout Covid-19. If the Pacific really is to be considered family, continuing labour mobility and finding solutions through this crisis must be front of mind.
To emerge in the best way possible from the Covid-19 pandemic requires us to understand the nature of the economic crisis. Our slowdown has arisen from deliberately-introduced frictions in human interaction at local, regional and international levels. While people remain able to trade in many kinds of goods, commodities, and some services (for example delivery), they are impeded from trading in things that require physical closeness to others or to objects and surfaces that others have touched.
In many countries, businesses that involve physical proximity – such as pubs and galleries – are shut down by edict, and their workers are asked to isolate in their homes. But such introduced frictions go well beyond shuttering business. We can sell our houses and buy classic cars with the proceeds, but inspecting homes or cars in person is now difficult, so we lose the crucial added value of salesmanship. We are able to give online lectures, but face-to-face lectures and tutorials are generally banned, suppressing the value added of live performance by charismatic speakers.
Access to public transport is restricted, making workers’ journeys from home to their job more expensive. In some cities, authorities allow robots to deliver goods and ban delivery by humans. Public auctions are banned but online auctions are not, shutting down specific labour of highly talented auctioneers who have mastered the art of selling. Executives are no longer able to travel internationally to strike the “deal of the century”, which requires sustained proximate interaction with counterparts. Successful managers who have honed their interpersonal skills are unable to manage large teams in person.
The only real exit strategy available to us is based on a fundamental principle of economics: we trade our way out.
At the international level, most human mobility has been halted. In some countries this has occurred at a regional level, too. This has occurred even while the ability to trade in most goods and commodities has been retained locally and internationally. Restrictions on human mobility and interaction will be tightened and eased by medical authorities as time goes by, depending on infection data. While this happens, there will be goods, commodities and services that can be traded without hindrance by health restrictions.
The only real exit strategy available to us is based on a fundamental principle of economics: we trade our way out. We should remove all barriers to trade in the goods and services that are not affected by the cycles of health restrictions. Free trade in unrestricted activities and goods at local, regional and international levels is essential.
Now is the worst time possible for trade wars and protectionism, either within or between countries. This is no time for trade barriers or preferential subsidies for local producers. It is time for governments around the world to take a hard look at industries that can export despite health restrictions, and remove all barriers to such activity.
If people are unable to travel from one city to another, even in the same country, then governments should encourage free trade between the cities by providing cheap trade infrastructure. Countries such as Australia should encourage the export of food, and in return they can import ventilators and trucks. Now is the worst time for failed notions of self-sufficiency, food security and import substitution by means of subsidies for local producers. Trade barriers are a sure way of achieving a prolonged recession.
In short, governments which are spending trillions of dollars fighting the economic effects of the public health lockdowns should be building trade infrastructure between their cities and connecting them to the rest of the world. Improve ports and airports, even though they may presently be empty. Improve rail for the transport of goods. Improve and widen roads between major cities to benefit truck traffic.
And finally, be aware that trade protectionists will sabotage our economic recovery using any excuse they can, including false claims about health effects and the public interest. They will see the pandemic as an opportunity to distort trade to their advantage.
When the Australian government asserted control over all new foreign investment two weeks ago in response to Covid-19, the move was sugar-coated with the reassurance the country was still open for business.
But with Prime Minister Scott Morrison now declaring his government is spending a “lot of time” thinking about domestic economic sovereignty, it is interesting that the Australian investment change seems to be the most wide-ranging in the world so far.
For example, Spain has introduced a 10% threshold, with special attention to some strategic industries. Italy has threatened new rules for strategic industries, and the European Union has issued new guidelines on screening health and biotech foreign investment.
While the jury may be out on the extent of long-term foreign investment re-regulation, the coronavirus crisis is set to send actual investment back down to levels not seen for two decades.
And while there have been some warnings about delayed approvals in the US system, law firm Skadden Arps says the “view of national security threats appears relatively steady, albeit likely more attune to risks from foreign investment in the US health care, pharmaceutical and related sectors”.
But fresh from one of the world’s larger fiscal rescue packages, Treasurer Josh Frydenberg has applied the same sort of Australian-model zeal to foreign capital by dropping all thresholds to zero and extending the review period to six months. He says of this comparatively tough action: “These measures are necessary to safeguard the national interest as the coronavirus outbreak puts intense pressure on the Australian economy and Australian businesses.” And in an unusually dramatic supporting explanation, the Foreign Investment Review Board goes as far as to declare that the tougher assessment rules are about “ensuring public order”.
It may well have been politically canny of Frydenberg to give himself carte blanche power of review in the middle of the pandemic rather than face diplomatic dilemmas over an opportunistic purchase – potentially from China – when there are more pressing economic issues to deal with.
But the question is how much of a political shift towards a new domestic economic sovereignty regime is really embedded in the changed investment rules, which dump the common $1.2 billion review free threshold previously in place for many countries.
It’s early days for a nation that has been dependent on foreign investment for economic growth. But when the law firm Akin Gump issued a note this week about the “erosion” of investor rights in Asian financial capitals including Tokyo, Singapore, and Hong Kong due to Covid-19 regulations, it was notably led by Australia’s new regime.
Follow the money
While the jury may be out on the extent of long-term foreign investment re-regulation, the coronavirus crisis is set to send actual investment back down to levels not seen for two decades.
The United Nations Commission on Trade and Development (UNCTAD) is forecasting a fall in global foreign direct investment (FDI) of 40% over the next year, with Asian countries feeling the decline first. The Institute for International Finance says emerging market countries suffered record outflows in March of US$83 billion, which was much greater than what happened during the 2008 global financial crisis.
Citi economist David Lubin says that the evacuation of money from developing economies “may be unprecedented”, with many now trapped between cutting interest rates to offset the burden of the pandemic and boosting them to stop capital outflow. He warns:
There is a decent case to make that we might be approaching a world in which policymakers start to restrict the movement of capital in the same way that they are restricting the movement of people and goods.
So, while the Australian government might be worried about an opportunistic takeover bid at home, the sharp decline in global investment is likely to create far bigger strategic problems for us if it destabilises neighbouring countries such as Indonesia.
Australia was a key bilateral financial supporter of Indonesia during the 1998 regional financial crisis the 2004 tsunami but has since shifted its development aid focus to the South Pacific nations, especially under the Morrison government. Any regional financial rescue package for pandemic ravaged Southeast countries would almost certainly need cooperation between China, Japan and Australia. But that is quite a different scenario to what has been playing out in the Pacific.
Geopolitical cold turkey
If there is one product that seems to top everyone’s list for local manufacture under any new domestic economic sovereignty policy, it is the stuff we buy at the local chemist shop.
Even before Covid-19 entered the public consciousness, this report was raising red flags about how chemist shop supplies, which are notionally imported from the US, are actually highly dependent on a Chinese ingredient supply chain.
But industry sources say local pharmacy companies are more concerned about the security of supply from India these days than China given the export bans already imposed by India and the uncertainty about how Covid-19 will undermine the country’s drug manufacturing capacity.
Of course, that is the same India that is often framed as a natural and reliable geo-economic ally of Australia in dealing with the rise (and implied threat) of excessive dependence on China.
It turns out that while India is the world’s biggest producer of generic drugs, it still buys about 70% of its ingredients from China. That’s an addiction that will be hard to kick.
It won’t come as any surprise to the sceptics, but the one country now claiming to be more foreign investor friendly in an otherwise de-globalising world is China.
While the country’s aid donations have been at the centre of a new soft-power push, last week the Commerce Ministry also said it would minimise the impact of the coronavirus crisis on foreign investment and encourage new money into various industries including technology.
In an indication of how the debate about diversification away from China is far from straightforward, this summary by law firm Herbert Smith Freehills of the latest foreign capital support measures as China reopens its economy observes:
We are hopeful that the impact of Covid-19 on foreign investment in China would be for a limited period of time. In the long run, we believe China’s comprehensive competitive advantages in attracting foreign investment, such as its huge domestic market, will remain unchanged.
Six locations across the Pacific Islands region now have confirmed cases of Covid-19. Many of these countries are already ravaged with major diseases such as malaria, tuberculosis, dengue, diabetes, and occasionally even polio. So Pacific politicians are all too conscious of the potential of any Covid-19 outbreak to tip over stretched, and in some cases broken, health systems.
Governments have quickly reacted by bunkering down and barring all international visitors, turning what is often perceived as a weakness – small size and isolation – into a strength. With this foresight and a bit of luck some of the Pacific may avoid the virus altogether, but much of it won’t.
Sadly, the region will not be lucky enough to avoid the economic fallout that is trailing in the wake of this virus. Pacific economies are dependent on the outside world – be it through tourism, commodities, trade, migration, or aid. Covid-19 will disrupt all of these economic ties.
Almost everyone on these islands lead import-dependent lifestyles – think staples such as rice and vegetables – and life could become quickly untenable if supply chains completely fracture.
For the tourism dependant economies, ANZ is modelling such stark figures as a 60% contraction in GDP in Cook Islands, and double-digit contractions in Fiji, Palau, Samoa and Vanuatu. Employment figures are even more harrowing, with close to 40% of Vanuatu’s slim formal workforce expected to be out of a job. Even when a vaccine is developed, tourism numbers are only likely to slowly ebb not flow back into the region.
The small atoll states of Federated States of Micronesia, Kiribati, Marshall Islands, Nauru, Palau, and Tuvalu might weather the economic storm the best because of sheer isolation. But almost everyone on these islands lead import-dependent lifestyles – think staples such as rice and vegetables – and life could become quickly untenable if supply chains completely fracture. Provided supply lanes stay open, existing incomes derived from fisheries, remittances, and aid should tide them through the crisis.
Commodity dependent economies such as Solomon Islands and Papua New Guinea will face their own challenges. Commodity prices are collapsing alongside demand. Mine sites and logging camps will struggle to maintain operations as foreign labour dries up. The challenge is particularly acute for PNG – the giant of the region with a porous land border with Indonesia. PNG was already in the midst of a slow-boiling economic crisis, and adding Covid-19 leaves the country little room to manoeuvre.
Most Pacific governments do not have the financial firepower to fight back against this economic collapse on their own. Budgets are already stretched and largely in deficit. Many countries are locked out from foreign debt markets, and those that do have access are charged crippling interest.
The Pacific needs help, and it will need it quickly.
Support packages are being assembled in Canberra, Wellington, and in multilateral institutions such as the World Bank. But what form should this support take? And how can Australia afford it as the nation deals with the largest economic crisis it has ever faced at home?
The response will have to be two-pronged, focusing on health and the economy.
Health support, much of which has already been mooted, will have to be responsive to the requests from the Pacific. Australia should emphasis supporting efficient testing, isolation, and quarantine – there is neither the personnel nor the time to equip the medical systems in the Pacific for treatment. Provision of basic medical supplies, testing kits, and protective gear will also be critical. With severe travel restrictions the military will need to be called on to assist in logistics and implementation.
Funding for health should be able to come from existing humanitarian and bilateral budgets. Travel bans will disrupt a lot of existing aid programs, allowing for significant repurposing of Australia’s $1.4 billion already being spent in the region. Care will have to be taken to ensure existing aid programs – the good ones at least – are able to resume once the crisis passes.
As Australia eventually gets the outbreak under control at home and more medical capacity is freed up, this support can pivot to supplement the region. Expect backing for public health systems, not infrastructure, to be a flagship of aid to the Pacific in the years ahead.
The economic needs of the Pacific are going to be far greater, and just as urgent. Expect a stimulus of at least 10% of regional GDP will be needed. Taking out PNG, that’s more than A$1.5 billion. With PNG, it could easily be more than $5 billion. The priority for this stimulus must be speed, focusing on keeping businesses, state-owned enterprises, and even governments solvent, and people employed. Many of the usual strings and conditions attached to budget support will have to be moderated.
Australia is not in a position to fund this alone. The existing aid program is insufficient, and there is justifiably little appetite on spending more abroad. Australia should immediately change the purpose of its recently announced $2 billion infrastructure lending facility into a broader program with very generous terms. A regional lending mechanism will need to be created to coordinate efforts from Australia, the Asian Development Bank, China, the International Monetary Fund, Japan, the World Bank, and whoever else is willing to help. This could evolve into a development bank for the Pacific.
For a region already struggling with debt issues such a move to bolster lending may actually create a future crisis for tomorrow, but it is the only way to help avert the economic disaster the Pacific is facing today.
Airlines are cancelling up to 90% of flights due to the rapid decline in travel brought on by Covid-19. Most of the world is being encouraged, or ordered, not to fly, and mandatory self-isolation is increasing common anyone arriving in more and more countries. That’s if they are allowed to enter at all. The travel industry is taking an unprecedented hit, and that will extend to the tourism sector more broadly.
The focus presently in Australia is appropriately on the domestic response to the unfolding health and economic crisis. But Australia’s long-standing overseas aid program also has a critical role to play in supporting the response in the region. That starts with helping fragile health systems to cope with this evolving crisis, which also reduces the chance of the further spread to Australia. But when the disease is eventually controlled and the recovery begins, industries around tourism will need support, else the flow on effects of Covid-19 will be even more severe.
The tourism sector has employed tens of millions of people in the countries in Asia that Australia provides development assistance (by our calculations, based on data from the World Travel and Tourism Council and the World Bank, as many as 40 million workers are involved). For the Pacific, tourist numbers are comparatively much lower, however the tourism sector has been a growing share of GDP and the sector employs nearly 100,000 people in Melanesia alone (Papua New Guinea, Solomon Islands, Vanuatu, and Fiji).
Avoiding the demise of small businesses and sectors critical to livelihoods such as tourism is also vital to ensure regional stability.
For many of those people dependent on the tourism sector, income diversification is rarely an option. Jobs in the tourism, including as drivers, hotel and restaurant staff, tour guides, transport operators and entertainers, generally go to low skilled or unskilled people. These people may migrate from rural areas to more urban areas in search of employment, and are in casual roles, which are highly seasonal and lack any sort of job protection or broader social safety net. The sudden and unprecedented drop in tourist numbers will mean sudden unemployment.
Initial estimates suggest Covid-19 will cost Asia up to $115 billion in lost tourism revenue. Visiting people in remote and rural parts of Asia shows firsthand how the tourist dollar dictates whether or not children go to school, whether or not adults access healthcare, and whether or not a family of four lives in a safe and secure home, or on the street.
Australia is blessed with universal access to high quality health care and sophisticated social security system that will help those affected by the pandemic with a safety net. Not all neighbouring countries are as fortunate.
In economics, unemployment benefits are often thought of as an automatic stabiliser, kicking in when the economy deteriorates and people most need the support. It’s not often that the overseas development program is described in this manner, but in the context of the current health and economic crisis, it may be an appropriate way to think about what is needed in Australia’s response in the region.
The aid program does not have the flexibility to pivot entirely to crisis response, but there is flexibility in the humanitarian aid budget. The immediate need in parts of Asia will be to ensure food and health supplies are available and accessible. Given many Australian development NGOs or their local counterparts have an existing presence in remote and rural parts of Asia, Australian aid can play an important role in getting supplies to communities in need.
In the longer term, the pandemic points to the priorities that must be part of Australia’s new aid policy, especially the importance of helping build health systems and skills in the region, not just infrastructure. Support for developing social safety nets to see communities through future crises is also essential.
At the same time, avoiding the demise of small businesses and sectors critical to livelihoods such as tourism is also vital to ensure regional stability, so as not to completely derail the development trajectory that had been underway. The cruise ships might not be welcome now. But in the months and years ahead, the dollars those tourist can bring will be essential to recovery from the potentially life-threatening economic impacts of a pandemic long after the health impacts are dealt with.
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 online summit between the leaders of Singapore and Australia on Monday didn’t get much attention amid a stock market meltdown and tensions within Australia’s newly formed federal-state leadership Cabinet to deal with coronavirus.
The virtual meeting made the best of international travel bans to sign off a new agreement on digital trade between the two countries, which in better times would have been pumped up as a pace-setting initiative to smooth the way for fast growing ecommerce amid troubled times for paragons of globalisation such as the World Trade Organisation (WTO).
Singapore and Australia have a long history and little to divide them. But as the world turns its back on international engagement in a desperate bid to deal with a disease pandemic, it will be bonds like this that will be necessary to restoring some cooperation when the WTO’s peers – such as the Group of 20 – are also struggling.
Meanwhile closer to home Singapore and Australia are just getting a view of what has always been one of their greatest shared economic and security nightmares – severe social dislocation in Indonesia, this time due to high death rates from undetected Covid-19.
In the heyday of new global economic institution building during the Global Financial Crisis (GFC), much was made of how the G20 economic leaders would straddle their many differences via a troika, bringing together past, present, and future leadership countries.
So, who’s on deck this year? Japan, acutely focussed on its failed bid to keep the Olympic Games on schedule; Saudi Arabia, more interested in oil price wars; and Italy, facing much more existential challenges.
Fortunately, the troika member-designate for the 2022 summit, India’s Prime Minister Narendra seems to have stepped into the vacuum to urge Saudi Arabia to bring forward this year’s G20 summit to today (Thursday).
Nevertheless, the lack of clear leadership this time around to parallel the example of Gordon Brown as British prime minister in 2008 will make behind the scenes trust between leaders (or countries) even more critical to getting a substantial G20 response.
Action by the G20 is made even more problematic by US President Donald Trump’s apparent preference for the older Group of Seven (G7) to deal with international issues, when he is interested.
When a vaccine eventually slows this pandemic, old challenges such as climate change and new challenges like another virus will still need global cooperation to find solutions, even in a less connected world.
But last week’s G7 leaders communique only underlined why the G20 was created to bring more diverse countries to the table: it went on for 800 words with no specific actions and no numbers. There’s been no identifiable collective action since. And there was also no mention of China, the original cause of the pandemic, but also now the country showing the most capacity to provide medical support to other developing countries.
It is hard not to see globalisation losing more momentum now that coronavirus has only added to the pre-existing centripetal forces from populist nationalism to lost faith in free trade. But when a vaccine eventually slows this pandemic, old challenges such as climate change and new challenges like another virus will still need global cooperation to find solutions, even in a less connected world.
While the G20 has had a post-GFC health stream, the 2019 Osaka communique notably focussed more on ageing demographics than pandemics and the whole G20 shift into new fields such as health has lost momentum as the group has flatlined since the GFC. (Read how Australia’s planning documents underplayed a pandemic here.)
In the meantime, there are many more immediate issues for today’s meeting. They include removing emerging obstacles to medical goods trade partly fostered by the US-China trade tensions, underpinning expansive actions by the World Bank and International Monetary Fund given individual rich countries are debt burdened, and planning for vaccine distribution. And given the extraordinary role of the global cruise ship industry in facilitating this pandemic, the G20 should be pushing for a global protocol.
As Australia’s GFC era prime minister Kevin Rudd argues:
Because of the entrenched interdependence of global public health, supply chains and financial markets, no single national response will work. Global action is not an optional extra.
When the much-vaunted idea of a Group of Two (China and the US) running the world had currency, a pandemic might have seemed like the potential moment for some cooperation.
But the unseemly sparring over the cause of the epidemic when China faces a reinfection cycle from returning citizens and the US seems at sea over a national control strategy, has only underlined how a caucus of other countries is needed to take control of this pandemic.
It is hard to see the US (and for that matter even more China dependent Australia) remaining as reliant on China for medical supplies after this experience. But like so many other aspects of the supply diversification debate that may not be the case for other countries now receiving Chinese aid.
And a crucial factor in the medical self-reliance battle will be how a Covid-19 vaccine is developed. Even if China is not first, it may well have the stronger pharmaceutical manufacturing capacity to deliver it quickly to the broader world.
Nevertheless, the willingness of the Chinese ambassador to the US Cui Tiankai to reject the claims by other Chinese officials that the virus was created in a US military laboratory offers the slimmest of hopes that the G2 may at least not impede some global cooperation at this crucial moment.
Asia’s social isolation
Asia has spent a lot of time since its own homegrown financial upheaval in 1997 talking up its capacity to manage a new crisis alone with institutions like the Chiangmai Initiative on currency reserve sharing.
At the same time the region’s oldest institution, the Association of Southeast Asia Nations (ASEAN), holds hundreds of meetings a year to reinforce the idea of growing pan-regional information sharing and cooperation. The Asian Development Bank has rushed out an assistance package for countries and businesses which is almost half that of the larger World Bank and is about to release a comprehensive economic impact assessment next week.
But it is striking that the coronavirus has not only seen little pan-regional institutional activity so far, but even more regressive actions on the cooperation front.
Taiwanese officials say the World Health Organization failed to take its early advice because it would have upset China and when the two most developed economies – Japan and South Korea – imposed travel controls they slipped into the sort of historical grievance sparring that has been going on for months.
What’s more striking is that even the countries that seem to be successful in dealing with the pandemic have pursued more organic local approaches rather than applying an agreed regional playbook drawn from their common experience of other pandemics. For example, Korea has emphasised aggressive testing, China a harshly enforced lockdown, Taiwan intensive contact tracing, and Japan much narrower testing.
However, as Asia plays a bigger role in the world, it is interesting and welcome to see the sinews of an Asian “model” for dealing with a global problem emerging in this crisis. But when these countries are being cited by the increasingly shrill media and academic critics of Australia’s national cabinet decision making on Covid-19, it needs to be appreciated that any Asian model is still fragmented.
And turning this emerging model into a confidence building policy package that can be applied more broadly in a future pandemic everywhere from the neighbourhood (Indonesia) to a faltering G7 member (Italy) will require some skilful multilateral institutional work.
Singapore and Australia have the trust, medical expertise and diplomatic links to at least help initiate this process in the Indo-Pacific.
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.
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.
For a second there the global economy was off to a slightly better start for 2020. The US and China finally inked an initial “phase one” trade deal that at least promised to pause hostilities for a while. That provided some much-needed respite for a world economy, which last year reached its weakest point since the global financial crisis. Shortly after, the International Monetary Fund was quick to provide a more upbeat global growth outlook, suggesting that slowing economic activity might be bottoming out.
Enter the Wuhan coronavirus. We can only speculate what ultimate impact – both human and economic – the virus will have, depending on how far it ends up spreading.
The most important channel of economic impact will likely be the hit to Chinese consumer spending. That’s less a function of the inherent danger of the virus – which is still unknown – and more about the precautionary response of the government and Chinese consumers leading people to stay home instead of heading to the shops, eating out, travelling or doing leisure activities. Other government containment efforts will also add to this – including lost output as businesses stay shut for longer following the Lunar New Year.
The indirect effect of a sharply slowing Chinese economy would be felt by others and could be a major difference compared to the SARS experience.
How big of an impact for the Chinese economy might this prove? Comparing it to the 2002–03 SARS outbreak suggests the shock could be substantial. While China’s economy continued to grow briskly through that episode, the underlying story suggests today’s experience could be quite different.
In 2003 Chinese consumption growth suffered a sharp slowdown. The economy was only able to escape a drop in headline growth because investment and exports were booming at the time, with China having entered its hyper export-led growth phase following its 2001 accession to the World Trade Organisation. The government was also able to help with stimulus measures.
This time around things are very different. Consumption is now an even more important driver of the economy while investment and exports have been weakening – reflecting China’s efforts to reduce its reliance on debt fuelled investment and pressure on the external front from the trade war with America.
There is also much less scope for sizeable stimulus today, with Chinese policymakers aiming to stabilise macro leverage in the economy in order to contain systemic financial risks. China might also be reluctant to let a weaker yuan serve as a natural exhaust valve – for fear of encouraging capital outflows but also potentially reigniting economic tensions with the Trump administration over the exchange rate. Having said that, if things worsen China’s top leadership may eventually judge that more support is needed to buttress things.
All up, if the Wuhan coronavirus crisis proves around the same scale as the SARS episode then China’s economy could conceivably be looking at economic growth dipping from the current 6.1% rate to something in the 4-5% range this year, even on the government’s rosy numbers. This is of course simply a guess. A lot of variables could influence that. A wider epidemic would spell bigger problems. Conversely, even successful government and public precautions might still impose a significant cost on the economy, if that is what it takes to halt the spread of the virus.
What might the impact be on the global economy? China accounts for about a fifth of world output on a purchasing power parity basis – the IMF’s preferred measure – meaning a Chinese slowdown to say 4.5% would directly knock off 0.3 percentage points from the fund’s latest global forecast of 3.3% for 2020 (made only last week). That alone would effectively wipe out the 2020 uptick in global growth that the IMF was hoping for, and instead keep the world economy growing at a similar pace to last year – already the slowest pace of global growth since the 2008–09 crisis.
Knock on effects for other economies could however make things worse. It is not clear how far the virus itself might spread in other countries. But the indirect effect of a sharply slowing Chinese economy would be felt by others and could be a major difference compared to the SARS experience. Not only are the risks of a sharp Chinese slowdown greater this time around but China is also now a far more important source of demand for the rest of the world, particularly in Asia.
What about for Australia? Australia’s tourism and education exports to China would appear most in the firing line. China has announced a halt to overseas tour groups. However, Australia’s tourism exports to China only amount to about 0.2% of GDP. Education exports amount to a more sizeable 0.6%. But the experience during the SARS epidemic was that education exports remained resilient, suggesting less cause for concern.
Meanwhile, the fact that the overall slowdown in China’s economy will be consumption led should help insulate Australia’s more important commodity exports from major damage (if China were to resort to renewed stimulus it could even provide some boost). Australia’s much less significant agricultural exports could however take a hit from weaker Chinese consumption.
A weaker Aussie dollar in response to increased global risk aversion and slower Chinese growth should however provide at least a partial offset – giving a boost to Australia’s international competitiveness, including tourism, education, and agricultural exports to other countries.
The economic risks for Australia therefore look less severe than some might fear.
All of this, however, depends on how far the virus ultimately spreads.