TWN Info Service on Finance and Development (Sept20/05)
24 September 2020
Third World Network

United Nations: Global recovery plan needed to avert a “lost decade”
Published in SUNS #9196 dated 24 September 2020

Geneva, 23 Sep (Kanaga Raja) – In the face of a deep recession in the world economy amid a still-unchecked COVID-19 pandemic, the time has come to hammer out a plan for global recovery that can credibly return even the most vulnerable countries to a stronger position than they were in before the onset of the COVID-19 crisis.

This is one of the main conclusions highlighted by the United Nations Conference on Trade and Development (UNCTAD) in its flagship Trade and Development Report 2020 (TDR).

According to UNCTAD, “an aborted economic recovery, or worse, another lost decade, is not preordained. It is a matter of policy choice.”

An inclusive recovery will require a willingness on the part of government not only to keep spending for as long as it takes the private sector to regain its confidence to spend, but also to tackle the underlying stresses and fractures that were already exposed by the global financial crisis, papered over, and left to fester for a decade, it said.

“It means addressing a series of pre-existing conditions that were threatening the health of the global economy before the pandemic hit, including high and entrenched inequality, sluggish growth, weak investment, endemic wage repression in the developed world and precarious working conditions in the developing world.”

The first thing to get right is avoiding the mistakes of the last crisis. That means maintaining an expansionary macroeconomic policy stance, appropriately balanced between its monetary and fiscal components, for as long as it takes the private sector to regain its confidence to spend, including, in particular, a strong investment drive, said UNCTAD.

“Avoiding a lost decade will require governments, particularly in the advanced countries, to stick to deficits for several years ahead,” it added.

“Hope of a rapid economic bounce-back from a scientific breakthrough – in the form of an effective and widely available vaccine – cannot blind us to other man-made dangers ahead. If governments opt for premature fiscal tightening in an attempt to bring down public debt and businesses adopt an aggressive cost-cutting strategy in an attempt to boost exports, the recovery will likely fizzle out, with a double-dip recession a real possibility in many countries in 2022,” UNCTAD cautioned.

At a hybrid media briefing (both in-person and online), Ms Isabelle Durant, the Deputy Secretary-General of UNCTAD, said “we are not yet in the post-COVID period or “in building back better”, even if this expression is becoming the new rhetoric.”

“Uncertainty has become the new norm,” Ms Durant said, adding that nevertheless in this forest of uncertainties, there are a few certainties that this TDR tries to analyze and comment on.

Mr Richard Kozul-Wright, Director of the UNCTAD Division on Globalization and Development Strategies and the main author of the TDR, said “clearly, we are not at the end of this crisis. I don’t think we are at the end of the beginning of this crisis. And that generates a lot of uncertainty and unfamiliarity.”

He said that the numbers that UNCTAD has projected have to take that degree of uncertainty and unfamiliarity in mind.

“That said, we continue to worry a lot about the disconnect between some of the language particularly of national policymakers about doing whatever it takes to address this crisis and a lot of global confusion and weaknesses in the response of the international community from which the developing countries are sure to be the biggest victims,” said Mr Kozul-Wright.

“It is worth bearing in mind that this is the third major crisis that the world economy is going through in the new millennium – the dotcom crisis, the 9/11 crisis, and the global financial crisis.”

“And now we have this crisis. I think it is worth asking the question – will this crisis take us closer to the brink or will it open up a new era of cooperation, stability and prosperity?” he said. “I think it is important to recognize that it will be policy choices and political leadership, not epidemiological destiny, that determines the course of the global economy over the coming years.”

As to what is coming next, Mr Kozul-Wright said that “what we expect to see next year is a technical rebound in the global economy that comes from the unlocking of the shutdown and combined with these very large relief packages that have been put in place.”

“We estimate a 4.1% increase in the global economy for 2021. That assumes policy continuity … We are assuming no change in the relatively aggressive macroeconomic stances, particularly monetary but also fiscal, over the coming year,” he added.

IMPACT OF COVID-19 ON GLOBAL ECONOMY

According to the UNCTAD report, before the pandemic, most analysts had expected world output to accelerate in 2020, pulled by faster growth in some of the larger developing economies, even as advanced economies continued their sluggish growth performance.

The pandemic has forced a reappraisal. As of mid-2020, the expectation of most private-sector, government and multilateral institutions is a sharp contraction of the world economy this year, concentrated in the first half of 2020, followed by an incomplete recovery, starting in the second half of 2020.

As measured by annual growth rates, the recession in 2020 will be much deeper than after the global financial crisis (GFC). Assuming that a second lockdown is avoided, the recovery is expected to continue through 2021, although world income is still unlikely to reach its pre-Covid-19 level by the year’s end.

UNCTAD said that it sees a similar pattern of a deep global recession followed by a technical bounce (as lockdown eases) and an initial recovery for this year but a full V-shaped recovery depends on policymakers doing everything right, a far from certain prospect.

And there are reasons to be worried about the pace of recovery next year, not only because of the non-negligible risk of new waves of the disease, but also because of the high uncertainty about the direction of economic policy and the absence of timely multilateral support on a scale commensurate with the challenging circumstances, particularly in developing countries, leading to deeper and more lasting damage from the Covid-19 shock.

UNCTAD’s baseline scenario, simulated through the United Nations Global Policy Model (GPM), and assuming the policy response this year is properly targeted and continues into 2021, indicates a 4.3 per cent reduction in world output in 2020 and a 4.1 per cent expansion next year.

“Compared to the average expectations of public and private institutions as of mid-2020, our scenario suggests a less severe downturn this year, but a weaker recovery next year,” it said.

In quantitative terms, considering that the average growth rate of the world economy – the pre-Covid-19 trend – was 3.0 per cent in 2017-19, UNCTAD’s baseline scenario means that world income will still be 6.4 per cent below its pre-Covid-19 trend in 2021.

Measured in terms of world gross product (WGP), the Covid-19 recession will likely amount by end of 2021 to a $12 trillion loss in global income, relative to a simple projection of the 2017-2019 trend, far larger than the TDR update expected in early March 2020.

Moreover, the growth recovery in 2021 will coincide with rising unemployment, which is likely to reach double digits in some advanced economies.

According to UNCTAD, this baseline scenario anticipates a wide fluctuation of the growth rate of global output in 2020-21, but a full recovery to the pre-Covid-19 trend by 2021 is unlikely for four reasons: (1) the world economy had a positive trend growth rate before Covid-19, so even with an expansion by 4.1 per cent in 2021, global income will not recover, in that single year, to the level expected before the pandemic; (2) the massive income losses of firms and families from Covid-19 have, and will continue to have, a negative impact on savings and income, raising private debt levels; (3) evidence from the GFC shows that monetary policy alone cannot bring the economy quickly back to its pre-shock situation. Fiscal stimulus is needed; the scale and composition of that stimulus will have a significant bearing on the trajectory of recovery; (4) based on what happened after the GFC, the necessary increase in government deficits and debt to fight the crisis may be prematurely aborted by fiscal consolidation; this could happen as soon as mid-2021 in many countries, which in turn would slow down the return to full economic recovery or even reverse it.

According to the TDR, the fragile state of the world economy going into 2021 should be a wake-up call for policymakers everywhere.

There is a high likelihood that if it is not, world output will not follow the V-shaped pattern that many are hoping for or even the stunted V that is seen as the more likely outcome. A prolonged recession or U-shaped recovery, a double-dip recession (W-shaped) or a permanent loss of potential output (L-shaped) are all possible trajectories.

POLICY RESPONSES TO COVID-19

According to the TDR, the first economic response of many countries to Covid-19 was to liquify financial markets to stop a credit crunch and deflationary debt spiral. Government emergency funds to support the health response to the pandemic also increased albeit, in many cases, not sufficiently to deal with the magnitude of the problem.

“This shortcoming created bottlenecks and rationing in health systems, in both developed and developing countries,” said UNCTAD.

What has made this crisis an unprecedented event, however, was the decision by governments to shut down economic activity in an effort to contain the pandemic, protect overstretched healthcare systems and save lives.

This sudden stop triggered automatic spending stabilizers, particularly in the more advanced economies with robust social security systems, but many governments adopted additional discretionary monetary, financial and fiscal initiatives to soften the blow to income, employment, and private balance sheets.

The TDR said the scale of these discretionary actions amounts to massive disaster-relief packages to support firms and families through the lockdown, as well as to aid local administrations in large federations whose revenues fell precipitously.

It is clear that monetary responses, in the forms of loans and guarantees and/or quantitative easing, have been the preferred response to the Covid-19 shock in advanced economies but that fiscal packages have been significant in a number of cases.

Both responses are significantly smaller in developing economies, where fiscal space is constrained and many central banks try to maintain a minimum precautionary level of international reserves to manage a stringent balance-of-payments constraint, however, fiscal packages have been significant in some cases.

It is still too soon to gauge the effective economic response of each country or region to Covid-19, or to separate what is a result of discretionary government decisions and what comes from exogenous support and endogenous mechanisms built into macroeconomic policy rules, said UNCTAD.

However, as of mid-2020, two things seem certain for coming economic policy discussions: this year there will be a deep global recession and a massive global increase in public debt.

Most policy responses to Covid-19 have been concentrated on relief or compensatory aid to firms and families, as well as preparation to deal with new waves of the disease. These measures have surely been necessary to save human lives and avoid an economic recession turning into a more prolonged depression, but the post-pandemic world will require more than disaster relief and prophylactic measures to recover from the current shock.

The state of the world economy was far from satisfactory before Covid-19 appeared, as argued in previous UNCTAD reports, and the current health shock has exposed many of the stresses and fragilities that need to be addressed for the global economy to become more resilient and move on to a sustainable economic, social and environmental growth trajectory.

Indeed, there seems little doubt that once the bottom of this crisis is reached, the world will not only be trillions of dollars worse off, it will be more unequal, more insecure, and more indebted than it was before. Governments will be more beholden to the vagaries of financial markets, large corporations will be more dominant, and the digital divide will have widened further.

Calls for a rethinking of the basic social contract (a “new deal,” or other monikers) have, not surprisingly, grown louder, said UNCTAD.

Economic reconstruction after Covid-19 will, above all, require active government policies to reduce income inequality while lowering carbon emissions; large public investment projects to generate jobs and accelerate the transition to a low-carbon energy-efficient economy and structural reforms to transition to new patterns of production and consumption, said the TDR.

“Developing nations will require access to sufficient and affordable financing and technology, along with more policy space, to make their contribution to a sustainable planet, as they also seek to close the economic and social gaps with advanced nations.”

Market forces alone are neither able nor suited to guide economic and social transformations on the scale required, including meeting the Sustainable Development Goals (SDGs) by 2030.

Indeed, the hyper-globalization era, despite establishing a business-friendly environment, has, in many countries, failed to deliver a fast pace of capital formation, in large part because of the spread to corporate boardrooms of an investment calculus drawn from financial markets.

That the recovery to the Covid-19 shock will require increased public investment, along with novel ways to manage fiscal constraints and imbalances, is indisputable. The experience since the GFC has shown that reducing the real interest rate to zero or negative values helps but it is not sufficient to spur market forces to stimulate investment and bring the economy back to full employment, let alone to transform current carbon-heavy patterns of consumption and production.

Significant government incentives for targeted investments and innovation combined with strategic planning will be required to accelerate green inclusive growth, including penalties or outright prohibitions on activities with clear negative externalities for social stability and environment preservation.

“All of this implies a mixture of more active fiscal, labour and industrial policies in the post-Covid-19 world. Policy must aim to recover employment and boost national income, and to shift its distribution, while also changing the underlying production structures,” said UNCTAD.

It noted that last year’s TDR (2019) showed that a large-scale coordinated investment push – upwards of 2 per cent of WGP and spearheaded by the public sector – to reinvent energy and other carbon-emitting sectors of the economy and radically alter production and consumption patterns was not only necessary but feasible.

An investment push on this scale will also need to tackle high levels of income inequality and at the same time, adopt more progressive fiscal arrangements, and directly target social outcomes through employment creation, decent work programmes and expanded social insurance.

Recent discussions dub such a strategy a “Green New Deal” recalling the efforts of the Roosevelt administration in the United States to tackle unemployment and low wages, the predatory nature of finance, infrastructure gaps and regional inequalities, in the context of recovering from the Great Depression.

“Given the nature of the climate crisis, and now the health crisis, such a programme would, at this moment in history, require a global effort,” said UNCTAD.

Enhanced international cooperation and coordination will be essential if genuinely taboo-breaking measures are to deliver on scale and on time and without themselves generating daunting challenges for future generations.

The leading countries and regions of the world, which have more material resources and policy autonomy to implement change in their own economies, will also have to support change in the rest of the world.

“Coordinating these packages and extending financial support beyond the core will require effective and active multilateral institutions,” said the TDR.

According to TDR, the existing multilateral architecture has, however, struggled to keep up with the challenges of a hyper-globalized world. Recovery strategies in some advanced and developing countries have included measures to help build resilience on both the health and environmental fronts, but international cooperation and coordination has been woefully short of what is needed or absent altogether.

The policy space for autonomous recovery and reconstruction policies is much more limited outside the United States, China, Europe and Japan, which only heightens the responsibility these countries and regions should assume in coordinating their economic initiatives and encouraging more progressive change in the rest of the world.

The Covid-19 shock has demonstrated the need for active economic policy in the face of an emergency. To save lives and preserve income and employment, governments of different political orientations have followed a mixture of Keynesian and monetarist measures, as they did in 2009, as well as more targeted policies on the supply-side.

Whether this was the best response to a self-induced economic coma will tax policymakers and commentators for some time to come However, the post-Covid-19 economic recovery will demand that, unlike after the GFC, policymakers do not abandon a pragmatic approach prematurely under the political pressure of vested economic interests and the intellectual influence of some defunct economists, said UNCTAD.

AVERTING ANOTHER “LOST DECADE”

According to the TDR, despite its tragic human cost, the global capacity of production did not fall substantially because of Covid-19 since the virus did not destroy productive capacity to the extent that cyclical downturns usually do. Nor is it the case that skills have suddenly been made redundant by a profound and permanent technological shift.

This may change if the pace of bankruptcies picks up dramatically over the second half of 2020 and if working practices undergo a longer term transformation, but to date there is idle capacity in many sectors and tens of millions of unemployed and underemployed workers across the world. The risk of excessive inflation, were governments to supply the demand so dearly lacking in today’s global economy, is as low as it has ever been in a lifetime.

In short, there is a window of opportunity to recover better. But the window will not remain open for long and there is massive uncertainty as to whether governments can muster the political will to make the required choices, ones that should be clear after the failed response to the GFC, said the TDR.

Either way, policy choices taken today matter for the direction of the economy over the longer term. As soon as the choices are made, one way or another, the dynamics of world economic and financial interactions will drive the outcomes that determine the quality of life for workers and their families, the investment opportunities available for businesses and the environmental health of the entire planet.

These dynamics are well-understood and show absolutely no sign of changing absent decisive action. The onus is on the world’s Leaders to avoid a lost decade (or worse), and make the choice to revive equitable, sustainable growth.

The Covid-19 shock caused a sudden stop in global supply and demand, with a negative impact on, and feedback from, financial markets, as debt ratios and financial leverage shot up. Given the huge decline in WGP in the first half of this year, the restarting of the global economy will result in a pick-up in many countries, but the path ahead is uncertain.

Part of the uncertainty comes from the fact that the global pandemic may have altered aggregate supply in significant ways, including the reorganization of supply chains and lasting effects on the labour force and technology. But it mostly comes from the demand side, since households, businesses and governments must take stock of their balance sheets in the face of lost income and accumulated debts before they start spending again.

Critical to determining the shape of any possible recovery over the medium term is the underlying structure of global demand. The world economy was unprepared for any serious shock, let alone one of the nature and scale of Covid-19.

This structural uncertainty is an outcome of the GFC – albeit with longer roots in the rules of a hyper-globalized economy – that is not as widely appreciated as it should be. During the last decade, the imbalances exposed by the GFC were not repaired. The debt overhang – private more than public – that brought the world economy to its knees in 2008 is more severe now than it was then.

The low employment rates and precarious nature of much work is affecting ever-larger segments of the world’s labour force. Income and wealth inequalities that have hampered economic growth and distorted distributional outcomes everywhere have worsened further, with governments vying with each other to extend tax breaks for corporations and high-wealth individuals and loosen regulations that favour those at the top.

The shrinking of the public sector as well as the tendency to fiscal austerity have continued. The weakness of investment in fixed capital and infrastructure – that further constrains capacity, productivity growth and income generation – has persisted. All these trends tend to encourage short-termism and speculative activities that lead to financial fragility.

“Mainstream economic analysis has contributed to the lack of preparedness of policymakers by promoting the wrong notion of resilience – one focused on doing business and foreign investors, rather than good jobs and income security – with an attendant narrowing of the aims and objectives of economic policy.”

The world largely abandoned the imperative of demand management with the turn to neoliberal policies in the 1980s and an exclusive focus on measures to boost growth from the supply-side. But especially since the GFC, there has been a greater awareness that inadequate growth of demand can cause a constant downward pressure on productive capacity and supply.

Conversely, productivity growth – the main variable supporting capacity and incomes over the longer run – can be triggered by a robust growth of demand and economies of scale that drive specialization.

However, there are constraints on a demand-driven growth path. One, and of growing importance, is the natural environment, and the present pandemic is a painful reminder that interdependency has many, sometimes tragic, dimensions.

Other pressing constraints of particular relevance to developing countries include lack of access to foreign currency and limited industrial capacity in a world economy that has become more and more dominated by big players. Another possible restraint on the growth of aggregate demand that weighs heavily on the minds of policymakers, in both developed and developing countries, is debt accumulation.

The TDR summarized that contractionary fiscal stances represent a dead-end for both developed and developing economies. For the former, for as long as fiscal spending multipliers are greater than one – which is the case except in the extraordinary circumstances of binding supply constraints – there are no macro-financial constraints to an expansionary stance, especially with low or negative interest rates.

For the latter, contractionary stances are not a valid option but resolving the financial bottlenecks requires support from global macroeconomic conditions and some degree of financial insurance, either regional or global. The binding constraint is thus the level of global support to growth and stability, a question of political economy.

The TDR also said that export-driven growth is not a feasible growth strategy for the world as a whole, and seldom even for individual countries in a world economy with deepening financial integration. It is a recipe for financial fragility, crises, and rising inequalities. It also depresses global demand in the mid-term and displaces development strategies as relatively less successful economies must earmark increasing portions of their income to service external liabilities while keeping up demand for exporting countries.

Once the immediate Covid-19 supply shock is over, the main threats to a full recovery of the world economy stem from two sources. One is the extent of business bankruptcies. While a number of high-profile bankruptcies have already been reported in the second half of 2020, these have not yet amounted to a cascade of cases that would adversely affect the financial sector through defaults and collapsing balance sheets.

It is however nearly impossible to make a precise prediction of what might follow, especially where the corporate debt overhang in developed and developing economies is un-precedently high, said UNCTAD.

The second cause for concern lies with the structure of global demand and income generation. If the forces required to launch a global recovery, one that would drive up incomes and restore stability, are not strong enough, or worse still if they run counter to a global demand reflation, the principal victims may not necessarily be large corporations operating worldwide. Instead, small and medium-scale firms, those operating in the informal sectors across developing and, increasingly, developed economies, the self-employed, and ultimately ordinary workers will suffer. Ultimately, the prospects for inclusive economic development will be severely undermined.

The review of the structure of global demand offers a framework to make an informed projection of what lies ahead based on current conditions and similar past events. The starting hypothesis is a potential reluctance by policymakers to reinstate a vigorous role for the public sector in sustaining a strong pace of demand growth, said UNCTAD.

Especially in the developed world, the existing economic structure remains geared to promoting either a debt- dependent, private borrowing-led or an export-led path to growth. Public sector demand injections are seen as a problem, not a solution. Moreover, calls for fiscal austerity have already resurfaced. This is reminiscent of the fiscal response to the GFC, which was initially strongly expansionary but was quickly followed by attempts to withdraw and effectively reverse the direction of fiscal policy.

“But the policy of austerity left scars as measured by a permanent loss of good jobs, decaying infrastructure, and weaker social safety nets. Ten years after, the growth of global demand remained inadequate,” said the TDR.

Similar results have followed other crises, particularly in the developing world. The most paradigmatic examples are the debt crises that hit Latin American and African economies in the 1980s. Similar cases include the crises in the 1990s, in East Asia, the Russian Federation, and again in Latin America.

In all cases, the period after was marked by severe adjustment to the public sector, leading to “lost decades” in terms of growth and development.

“The main difference this time around is of a perverse kind. The size of the acquired public sector debts is un-precedented and across all countries. If austerity emerges as the winning policy option, the consequences are most surely going to be of comparatively gigantic proportions.”

A lost decade for the global economy – or rather another lost decade – is a plausible outcome. But a lost decade is not inevitable. Any sustainable global macroeconomic strategy must achieve a combination of mid-term objectives: robust economic growth, industrialization and development, inclusiveness, employment, financial stability and, importantly climate change mitigation. Together these can determine the macroeconomics of a well-functioning global economy.

“The priority for economic policy must be ensuring a real recovery of economic expansion that puts people back to work and restores income growth, while also ensuring that the financial imbalances left by the Covid-19 shock are repaired,” said the TDR.

It is not too late yet for an effective stimulus to global demand. As long as productive capacity remains in place, workers have not lost skills or left the labour force and creditworthiness remains robust, a globally coordinated effort to spur demand has a real chance of restoring growth. With the private sector everywhere in “wait and see” mode, the initiative simply must come from the public sector.

Injections of public-sector demand into the economic system can boost incomes across the economy thanks to high multipliers. Only a strong fiscal expansion can bring unemployment down quickly enough to avoid permanently damaging workers, and it can only wind down carefully once the private sector is able to pick-up demand.

The vision underlying the growth revival scenario, consistent with the SDGs, requires simultaneous attention to three global public goods: environmental protection, economic development of all nations, and financial stability. Like environmental protection, economic development in a globally integrated economy brings common benefits.

According to the TDR, strong domestic demand support in countries with a current-account surplus is necessary to put the world economy on a sustainable and robust growth path, while also promoting industrialization in the South. Combinations of financial support, technology transfers and especially by increasing market access and injections of aggregate demand can achieve this goal.

This will help to raise the share of exports of manufacturing products produced in the South, it said.

In the growth revival scenario, advanced surplus economies will reduce their imbalances by relying more heavily on faster growth of domestic demand. The complementary effort to back industrialization of emerging economies will work in the same direction. Meanwhile, advanced economies running current-account deficits improve their external positions without completely eliminating the deficits. Finally, the growth revival scenario assumes an international financial architecture that functions for global stability and development.

More generally, moving in the direction of the proposed growth revival scenario calls for policy focus and bold measures. Domestically, economic planning and industrial policies will be essential; internationally, policy coordination will be needed.

Though both approaches have been part of the policy discourse in the past, implemented by both advanced and emerging economies to some degree, they imply a change of course with respect to the current policy mind-set.

There should be no denying the fact that changing course is becoming harder over time. Self-restraint by policymakers, sometimes to even discuss the possibility of stimulus, has become habitual, effectively reducing the institutional space to operate. Governments have downsized in the name of austerity, outsourcing and privatization, but the size of their financial obligations have expanded disproportionally by absorbing debts contracted elsewhere.

In honouring debts, promoting the creation of liquidity to rescue bank balance-sheets, and relaxing the rules, they have contributed to the creation of financial giants that are “too big to fail”. Thus, States have not only become smaller but also weaker in comparison. Meanwhile, the enlargement of rights, protections, favourable tax treatment to corporations, and other forms of abidance to corporate power and international investors has, pari passu reduced the ability of workers to raise their wages.

Still, under the present conditions where States and wage earners are relatively weak, they still represent the sole possibilities of raising effective demand to avert a continuing global economic decline that will leave all parties worse off. To realize such possibilities, the role of fiscal policy has to be reinstated; corporate power has to be regulated in exchange for a continuing and stable source of prosperity; credit instruments to sustain production while averting speculation have to be reinvented; and employment and fair remunerations ensured.

The argument, after a crippling financial meltdown that led to a decade of insipid growth and increasing financial fragility, should be obvious in light of the Covid-19 crisis. What remains to be seen is whether there is the political willingness to coordinate a global recovery plan, the TDR concluded.