May 14, 2020

US
by IESE Business School

The Great Shutdown: Challenges And Opportunities

By Eduard Talamàs, Assistant Professor of Economics at IESE Business School.

No one really knows how the Covid-19 pandemic will play out. One thing is certain, however: it is causing a
dramatic global economic crash. This of course creates abundant challenges, but also invaluable opportunities
to tackle longstanding problems.

Challenge #1: Crashing developing and emerging economies.

Inadequate medical capacity, weak institutions, massive capital outflows, lower remittances and a sharp fall in
export revenues are wreaking havoc in most developing and emerging economies. Hundreds of billions of
locusts swarming through East Africa will not help either.

The opportunity: Rich nations can step up their help.

Rich nations can provide much-needed help by, for example, partially relieving previous debts, expanding the
IMF and World Bank loan programs, and supporting the UN’s Global Humanitarian Response Plan. If nothing
else, this is in their own interest: developing and emerging markets now account for more than half of the
global economy. Helping them push through this storm is important not only to tame the pandemic and to
prevent a humanitarian catastrophe, but also to ameliorate the global economic crash.

Challenge #2: The unequal economic effects of the pandemic.

The most vulnerable individuals are being hit the hardest. Lack of stable employment, inadequate housing,
and low savings make lock-downs especially daunting. Home schooling is particularly hard in homes that lack
peace, balanced meals and internet access. Numerous innovations with the potential to displace millions of
low skilled workers (e.g., driver-less vehicles, self-checkout stores, e-commerce, 3-D printing) look ever more
promising. As we have recently experienced across much of Europe and the Americas, such inequalities—and
the bitter politics that come with them—can lead to dysfunctional governments.
The opportunity: Institutional reforms.

The evident failure of public institutions during this pandemic—combined with the resulting deep economic
crisis—is bound to lead to widespread frustration. Anticipating these frustrations—and pursuing long overdue
political, tax, healthcare and labor market reforms that help address them—not only is the right thing to do,
but it could also prove key in the defense of our liberal democratic political systems against populism and
authoritarianism.

Challenge #3: Inter-generational tensions

Many of the young saw their careers permanently damaged by the Great Recession. They are now about to
see their careers further damaged by the Great Shutdown. The lucky ones who manage to remain employed
will be responsible for funding enormous public deficits and unsustainable pension systems. As France’s Gilet
Jeunes recently reminded us, this might not end well.

The opportunity: Pension reforms and smart public investment.

The simultaneous ballooning of youth unemployment and public debt might provide a window of opportunity
to undertake badly-needed pension reforms that are politically toxic in normal times. Once the health
emergency is under control, and the time comes to stimulate the economy via public investment, it might also
facilitate investments that especially benefit the young, like education (of all kinds), clean electricity and
transportation, affordable housing, and reliably-fast broadband.

Challenge #4: Monetary authorities are navigating a dangerous and uncharted territory.

Most of the advanced world is in a liquidity trap (close to the zero lower bound on short-term nominal interest
rates). Massive fiscal support programs and purchases of government bonds are blurring the boundaries
between monetary and fiscal policy. This is sounding many alarms and raising fundamental questions—from
the democratic adequacy of central banks’ independence, to the potential inflationary effects of the
unprecedented expansion of central banks’ balance sheets.

The opportunity: Upgrade the international monetary system.

The extraordinary monetary measures of the last decade were sold as being the natural response to an
extraordinary financial meltdown. This time around it will be much harder to argue that our monetary troubles
are not, in fact, much more fundamental. Central Banks can use this opportunity to reform their policy
frameworks. For example, raising their inflation targets to try to escape from the crippling liquidity trap seems
long overdue. This crisis could also serve as a good excuse for central banks to fully embrace the digital
payments revolution.

Challenge #5: Globalization backlash

Countless previous financial crises have shed light on the dangers of global finance. Japan’s 2011 Tohoku
earthquake and tsunami evidenced the fragility of many modern global supply chains. The recent eurozone
debt crisis showed how badly designed the European monetary union is. These fragilities are now all evident
at once. The export controls of critical medical supplies seen during this pandemic will also make it much
harder to brush off concerns about national security and self-sufficiency.

The opportunity: Upgrade the rules of international trade and finance

The globalization backlash provides a good opportunity to take stock of the pros and cons of our current
forms of globalization, to defend their most beneficial aspects, and to reform the rest. On the one hand, we
should keep in mind that globalization has lifted millions out poverty in the last few decades, and that it has
the potential to lift millions more in the coming years. On the other hand, we should take much more
seriously the harmful effects that international trade has on many individuals, as well as the disastrous effects
that financial globalization can have on countries with relatively weak institutions.
Challenge #6: Geopolitical shake-up

Tensions are rising between the US and China. After years of escalating animosity—including damaging
technological and trade wars—both sides are now blaming each other for the pandemic. Their conflict is
undermining international organizations like the World Health Organization when the world most needs them.

The opportunity: More international cooperation

All countries have now two common enemies: the pandemic and its associated global economic crash. This is
an invaluable opportunity for governments to leave their differences aside and work together against these
global enemies. It is also a good opportunity to reckon with China’s growing global importance—and, more
generally, with the troubling resurgence of authoritarianism across the world—and to reform our major
diplomatic institutions accordingly.

To conclude, while we focus on tackling the current global health and economic crises, let’s keep in mind that
much bigger challenges lie ahead: Deadlier infectious diseases are out there. Cyber-warfare can lead to more
damaging economic shutdowns. The threats posed by climate change are more existential—and more difficult
to solve too. We would do well to take the current crisis as an opportunity to prepare for the abundant global
challenges ahead.

Pay heed to inequality

The wealth gap was widely considered a defining economic story of the century long before the coronavirus
swept the world. Now, the situation is set to get even worse.

In the short-term, we should be mindful that oftentimes the less you earn, the less likely you're able to work
from home. Moreover, economically disadvantaged people generally have a higher probability of getting sick.
And, in places like the United States, they may lack healthcare.

Then you have the issue of emerging economies so often being dependent on commodities. In Angola, for
example, 88% of exports are linked to the oil sector. When you combine that with weak institutions, you can
bet on very serious trouble.

These are just glimpses of a few reasons why the impact will cut in different ways and combine to take a
devastating toll.

To face the future, face reality

Recent research by economists from the San Francisco Fed analyzed the long-term impact of previous
pandemics. According to the findings, the effect that this crisis has on salaries and interest rates could last for
years. We’re talking about a crisis that will have a more durable impact than major wars. The good news is that
according to this research, the effect on wages was actually somewhat positive in the long run.

In the shorter-term, we might optimistically say that the global economy will be getting back to normal shape
by 2021. The recent estimates of the IMF are looking at 5.8 % growth for the global economy in 2021, but this
expectation is dominated by uncertainties. Getting back to normal relies heavily on not just the development of
a vaccine, but its production in massive quantities and safe, international distribution.

All of this demands that more preparatory fiscal steps be taken, and soon, in advance of a second wave or,
perhaps, even another pandemic. We're not talking about the next two weeks. We're talking about the next
several years. It’s a timeline that requires better, more immediate and coordinated efforts than what we’ve
seen so far.