Beware of overestimating global economic recovery from coronavirus

Despite some good news, many economies across the globe have flat or negative growth while central banks have fewer tools to respond than in 2008
Governments have only one good option – further aggressive fiscal stimulus, ideally via targeted government expenditure that could spur private investment

Eswar Prasad

Published: 4:30pm, 16 Oct, 2020

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The world economy has risen from the depths of the initial Covid-19 plunge. However, the recovery has been tepid, uneven and fragile and is likely to remain so for the foreseeable future.

Start with the good news. World merchandise trade has rebounded, consistent with indications of a revival in household demand for goods in many economies, even as public health restrictions and consumer concerns continue to hobble demand for services.

Moreover, financial markets have held up surprisingly well with stock markets in many countries returning to pre-pandemic levels. Despite near-zero interest rates, banking and financial systems seem largely stable. Consumer and industrial demand have buoyed commodity prices, with even oil prices having recovered somewhat.

As the latest Brookings-Financial Times Tracking Indexes for the Global Economic Recovery update shows, though, many economies are experiencing essentially no growth or are even contracting. With private-sector confidence depleted and the struggle to contain the virus far from over, the risks of substantial, long-lasting economic scarring are on the rise.

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This is true even in economies that have returned to growth, such as the United States. In some ways, the US seems to have turned the corner. Industrial activity and the labour market have regained some lost ground. The unemployment rate is falling and employment levels are up.

However, unemployment remains higher and employment lower than before the pandemic. The increase in long-term unemployment, together with ongoing service-sector disruptions, portends a difficult path to a more robust recovery.

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It doesn’t help that fiscal stimulus measures have lapsed and negotiations on a new relief package have repeatedly broken down. As household disposable income declines, private consumption growth has weakened. Similarly, business investment continues to contract, which does not augur well for sustained growth.

Even stock markets, which experienced a sharp rebound earlier in the year, seem to be taking a breather. This may reflect concerns about the virus containment strategy – or lack thereof – by US President Donald Trump’s administration. As next month’s presidential election approaches, heightened political and policy uncertainty is likely to keep consumer and business confidence muted.

The euro zone is in even worse shape. Not only has the pandemic hurt short-term growth, deflation is raising the risk of a deep, prolonged contraction. While manufacturing in Germany and elsewhere has rebounded, the positive effects are offset by the enduring services slump, reinforced by ongoing public health restrictions.

Pedestrians pass a coronavirus prevention information poster in Berlin, Germany, on October 15. Photo: Bloomberg

The United Kingdom’s services sector, by contrast, has experienced a revival. Even so, the combination of erratic lockdown policies and uncertainties surrounding Brexit are contributing to continued economic contraction. Meanwhile, on the other side of the world, Japan is also in serious economic peril, though it has so far avoided sliding back into deflation.

Most emerging economies have not fared well, either. India is experiencing a sharp slowdown in economic activity exacerbated by an acceleration in Covid-19 cases fuelled by the easing of lockdown measures. The government has pushed through some agricultural and labour market reforms, but a banking system hobbled by bad loans remains a powerful constraint on growth.

Brazil and Russia have fared little better. Both have experienced substantial economic contractions and have few policy levers available to revive growth.

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The one country experiencing a strong recovery is China. Thanks largely to its apparent success in bringing the virus under control, its industrial production and services have rebounded. Retail sales and manufacturing sector investment have also recovered. By many indicators, its economic performance is stronger than it was before the pandemic.

Unlike after the 2008 global financial crisis, though, China’s strong performance is not likely to do much to buttress the rest of the world economy, not least because of the growing push towards deglobalisation. China’s recently unveiled “dual circulation strategy” – whereby it will increasingly depend on the domestic cycle of production, distribution and consumption for long-term development – will reinforce this trend.

Making matters worse, central banks have far less firepower than they did after the 2008 crisis. The major central banks have pulled out all the policy stops since the pandemic began, pursuing unprecedented monetary expansion to support economic activity and fend off deflation. Some – most notably the US Federal Reserve – have even adjusted policy frameworks to signal tolerance of higher inflation.

The limits of monetary policy for boosting growth are increasingly apparent. Meanwhile, large-scale purchases of corporate and government bonds, together with the direct financing of firms, are generating serious risks, not least to central bank independence.

Against this background, governments have only one good option – further aggressive fiscal stimulus, ideally in the form of targeted government expenditure that could spur private investment. Whatever risks the increase in public debt might generate, they do not compare to the long-term economic pain that countries will face without such stimulus.

To be effective, however, fiscal measures must be complemented by coherent virus containment strategies which credibly enable safe economic reopening. Without such strategies, demand and confidence will remain subdued and global growth will continue faltering well into the future.

Eswar Prasad is professor of trade policy at Cornell University’s Dyson School of Applied Economics and Management and a senior fellow at the Brookings Institution. Darren Chang and Ethan Wu, undergraduate students at Cornell, assisted in the writing of this commentary. Copyright: Project Syndicate

David Dodwell is on holiday

This article appeared in the South China Morning Post print edition as: Global recovery shaky

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