Written by Paul Sheard
This article appeared in Briefing for Britain, and we republish here with kind permission.
*This is the second part of a two-part article. You can read the first part here on Independence Daily.
The COVID-19-triggered recession has highlighted some serious fragilities and vulnerabilities in the global economic system. Not to make light of the death and suffering, by some measures and perspectives, the shock to the global economy system represented by the coronavirus itself is a relatively small one. As of the time of writing, the World Health Organization estimate of total deaths from COVID-19 stood at 800,906, which is not much higher than a very bad influenza season (estimated at 650,000 deaths), and represents about 1.4% of estimated annual global deaths. Yet, via the “policy reaction function,” the impact on global growth has been dramatic.
This should give policymakers, investors and citizens pause. We are far from being out of the woods with this pandemic, but how prepared are governments, economies, and societies for future epidemiological, geopolitical, cyber, socioeconomic, climatic or other shocks?
At one level, the inherent fragility of the hyper-globalized world economy should not be surprising. Markets are very good at “optimizing” but they are not good at “robustness:” the very efficiencies that markets are so good at squeezing out deprives economic systems of the redundancies and slack that might be needed when unexpected contingencies occur.
But there are also concerns about how well equipped governments are, both individually and acting in concert, to deal with COVID-19-type shocks in terms of their information-gathering, decision-making and crisis-response capabilities. In this crisis, many governments have turned to their in-house medical experts, who have suddenly been thrust into high profile policy advice and public communication roles for which they may be ill-prepared and ill-suited. In the COVID-19 post-mortem, political leaders and governments will need to pay serious attention to the question of how better to equip themselves with effective crisis-management tools and frameworks to deal with a range of future contingencies.
The COVID-19 pandemic looks set to have an impact of the economy, society and polity that goes well beyond its near-term impact on the path of GDP, as significant as that is. It is likely to amplify and accelerate a number of existing or nascent trends, as well as produce some new ones that defy discerning from our current vantage point.
Perhaps most obviously the pandemic is likely to have a lasting impact on the nature of work, particularly in the “knowledge economy,” as companies and employees embrace telecommuting and as companies reevaluate not only their real estate footprints but how “virtual” and cloud-based they want to become. More generally, urban life stands to lose some its attraction or at least for many increasingly become a smaller part of a portfolio of locational and life-style choices.
The “globalization” pendulum is likely to swing back a bit further particularly when it comes to the near-shoring and re-shoring of manufacturing supply chains, as the pandemic has highlighted that sovereignty and borders matter more than some thought, and that it is worth sacrificing some pursuit of efficiency in the service of being more self-sufficient.
Because the coronavirus originated in China but so far has wreaked its most damage in the US and Europe, the fault lines that had been developing in US-China relations stand to be accentuated even further, and the geopolitical and geo-economic realignment of the world into US-centric and China-centric spheres of influence is likely to accelerate.
A big concern is that both the negative impact of the pandemic and the positive impact of the recovery from it will exacerbate income and wealth inequalities within countries (so far the advanced economies have been impacted more than emerging economies but this could change).
One of the disconcerting (although from a purely economic viewpoint not necessarily unwelcome) features of this recession, particularly in the US, is the apparent disconnect between the performance of financial markets and that of the real economy, meaning that those with significant financial wealth have done well. US real GDP fell by 10.6% (on a non-annualized basis) in the first half of 2020 and yet the S&P500, at the time of writing, is just 1% shy of its mid-February (and all-time) high. And the brunt of unemployment and wage income destruction has fallen on less skilled segments of the workforce, while “knowledge workers” have been able to “work from home,” that home oftentimes being a second one away from the angst of the locked-down city. The seeds of (further) social unrest and erosion of social capital may be being sown.
Even before the pandemic-triggered recession, the macroeconomic policy world was having a bit of a mid-life crisis. The “natural rate of interest,” that is, the real interest rate associated with the economy being at full employment with price stability (or in central banking-speak, R-star) , appeared to be permanently low, if not even negative, a state of affairs Harvard economist Larry Summers has termed “secular stagnation.” A consensus was forming that, in future, fiscal policy could and should play a bigger role in macroeconomic policy management than in the past several decades. The macroeconomic policy framework, resting on a strict separation of monetary policy from fiscal policy and the assignment of the prime responsibility for managing the macro economy to an independent, technocratic central bank, was looking increasingly in need of overhaul.
The pandemic recession has likely pushed the natural rate of interest even lower and reduced the chances that it will revert to anything resembling a twentieth century norm any time soon. This is not only because of the big hit that already weak aggregate demand has taken but also because of the spur to the virtual economy delivered by the pandemic response, both of which factors are likely to lead to (desired) savings exceeding (desired) investment, the stuff of lower R-star.
The all-hands-on-deck policy response to the pandemic recession has already precipitated aggressive coordinated, if not joint, policy action by the monetary and fiscal authorities. This trend will likely continue and increasingly become codified in changes to the macroeconomic policy framework. By the time the long-awaited respective strategy reviews of the Federal Reserve and the European Central Bank are released, they may be looking anachronistic.
How much of a global gamechanger COVID-19 ends up being is hard to say, but the scope for it to be up there with the likes of the Great Depression cannot be dismissed.
Paul Sheard is a Research Fellow at the Mossavar-Rahmani Center of Business and Government at Harvard Kennedy School. He formerly held chief economist positions at leading institutions in New York and Tokyo.
First published in Woori Financial Plus, 9 August 2020