A disrupted world

April 10, 2020

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The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.
The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.

“Everybody knows that pestilences have a way of recurring in the world; yet somehow we find it hard to believe in ones that crash down on our heads from a blue sky.” — Albert Camus, The Plague, 1948.

WHILE the global pandemic sweeping the world has been described frequently as a black swan event, a devastating pathogen attack on large swathes of humankind is not the ‘25-sigma’ event it is made out to be. In fact, Nassim Nicholas Taleb, the celebrated author and coiner of the term ‘black swan’ has dubbed the coronavirus pandemic as a white swan, given that it is not the once-in-human-history event it is being portrayed as by commentators around the world. Plagues and pestilence have been around, but have been ignored at our peril.

As pointed out in an excellent background paper by Olga Jonas of the World Bank for the 2014 edition of the World Development Report, the OECD, insurers and risk management experts (and Bill Gates too) have long categorised a global pandemic of the nature the world is currently experiencing as among the top threats to humankind.

Be that as it may, the unprecedented speed and scale of the global disruption and dislocation we are experiencing as a result of the pandemic has a ‘never-before-in-history’ feel to it. While many US economists initially felt that the resulting recession will be severe but short-lived, invoking the letter ‘V’ to denote the expected shape of the recovery, more and more have been likening it to the shape of ‘U’ — or even ‘L’, where the post-virus economy flatlines for a long period of time.

As the pandemic progresses, the mainstream outlook appears to be becoming ever more dismal, prompting Ezra Klein to write in a recent Vox piece that “as the Covid-19 pandemic worsens, it’s hard to decide which are scarier: the conversations I’m having with epidemiologistsor the conversations I’m having with economists”.

The impact of the pandemic is likely to be deep and far-reaching.

Nouriel Roubini was among the first to point out that so far, the ‘sudden stop’ on the supply side is more ‘I’-shaped than anything else, and the prospects for a quick global recovery are uncertain. He believes that the “the risk of a new Great Depression, worse than the original — a Greater Depression — is rising by the day”. The Harvard professor and ex-chief economist of IMF Kenneth Rogoff has sounded warnings in a similar vein. Mark Zandi, the chief economist at Moody’s Analytics, has described the situation as an “economic tsunami”.

Why is the view among many respected mainstream commentators becoming ever more pessimistic? The increasing concern stems from the damage to the real economy that may be wreaked in the worst-case scenario by a self-reinforcing negative feedback loop of plummeting consumption and investment spending, reinforced by rising business bankruptcies and unemployment, which feeds into a sharp curtailment of bank credit due to impairment of financial institutions’ balance sheets.

A vicious cycle of falling consumption and investment spending driving output lower — and increasing the (negative) output gap — is a classic deflationary spiral that is so hard to break out of. While most major economies, especially the US, have acted quickly and put together impressive stimulus measures, as of now, the policy stimulus does not appear to be nearly enough, nor does it seem to be reaching the affected segments quickly enough. Despite the policy stimulus, the real and present danger is that broken global supply chains and disrupted transportation and marketing channels, combined with swelling ranks of the unemployed, will in the short run lead to a detritus of failed businesses, and ruptured flow of credit in the longer run.

If the pandemic continues for longer, or makes a second and third resurgence as other virus outbreaks have in the past, consumers will remain fearful — thus removing a key pillar of an eventual economic recovery. Because the money directed via ‘helicopter drops’ into consumer’s hands will go to build precautionary balances and only be used minimally for maintenance spending, the impact of stimulus measures will be diluted. (For this reason, it appears to me that we should be worried more about deflation than inflation in the months ahead).

To sum up, as I had written in my previous opinion piece in this newspaper (‘A full-spectrum response’): “[t]he effects of an immediate supply shock — with production at a halt, supply chains disrupted, and shipments stopped — will be amplified by a subsequent demand shock caused by the global economy tipping into a ‘recession’… the knock-on impact on economies, firms, jobs, livelihoods and wealth around the world is approaching a seismic scale”.

While clearly the speed and strength of a post-pandemic recovery will depend on the public health response of authorities and the pace, scale and robustness of economic measures by policymakers, the economic impact of a pandemic appears to linger for a protracted period, according to a recent working paper by the Federal Reserve Bank of San Francisco.

However, these are not the only effects that the pandemic is likely to engender. Rising nationalism, and growing calls for protectionism and reversal of globalisation that preceded the pandemic will be amplified. With less reliance on global supply chains, the trend towards ‘re-shoring’ by advanced economies is likely to intensify, potentially removing exports as the main building block of emerging markets’ growth models. Developing countries will have to be ever more agile and nimble to navigate the longer-term challenges ahead — and demonstrate the capacity to think beyond near-term palliatives such as emergency assistance and debt relief.

As an astute commentator noted recently, world history may have a new demarcation going forward: the pre-Covid-19 vs post-Covid-19 period (much like ‘Antediluvian’ refers to of, or belonging to, the time before the Biblical flood).

The world — not just in terms of the economy, but also in terms of the political order — may be very different at the other end of the tunnel.

The writer is a former member of the prime minister’s economic advisory council, and heads a macroeconomic consultancy based in Islamabad.

Published in Dawn, April 10th, 2020