Facing the ‘tsunami’
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File picture of a store in Badulla plastered with COVID-19 information.
Someone raised a timely valid point in a recent discussion: The US and Europe – the richest regions on the planet, became the epicentres of COVID-19 issue, because these countries were reluctant to adopt a strict lockdown strategy. China, on the other hand, adopted a strict lockdown strategy and, managed to keep the issue more localized confining it to a particular area – Wuhan city. I am sure there might be more than one argument underlining these points.
Had the US and Europe, adopted a strict lockdown strategy, its economic cost would have been massive; the adverse effect of burning down a 100-acre harvest is bigger than burning the harvest of a quarter of an acre! The frightening situation now is, either with or without a strict lockdown strategy, the outcome is becoming the same and in the world economy, it’s already there.
Economic epicentres
The world’s biggest production and consumption take place in three locations on the planet – the US, the Euro area, and China. The nations in these three locations together produce more than half of the world output and consume more than half of the world consumer supplies. Nearly 60 per cent of the world investment takes place in these locations, enabling them to produce such a big output.
If we add another two nations to this group – the UK and Japan, then nearly two-thirds of the world economy is represented. The economic size of these nations are critically important for the world economy and for every country that is connected to them irrespective of whether they are small countries or big countries. It is because, on the one hand, they don’t produce only for themselves. Part of their production is for the use of other countries too. On the other hand, they don’t consume only what they produce at home. Part of their consumption comes from produce sold by other countries.
Well, apparently every country is producing part of their output for other countries and consume part of the output of other countries. There is nothing strange here. But the above nations are important for the rest of the world, because of the size of their output, income and expenditure. Nearly half of the world’s total exports originates in the US, the Euro area and China; they buy nearly half of the world’s total imports too.
Rise of the tidal wave
The rate of economic contraction of the US, the Euro area and China for the first quarter of 2020 was reported last week. All three locations show a contraction of their GDP by 4.8 per cent in the US, by 3.8 per cent in the Euro area, and by 9.8 per cent in China. The numbers show the magnitude of the rising tidal wave. With the rising economic tidal waves sweeping across these big nations, the world can already see the devastating impact that it would have in 2020.
If the recession continues to drag on to the subsequent years, then the world would experience the second Great Depression in the 2020s, after the first one being in the 1920s-1930s. The economic slowdown is a global one and a massive one so that the rest of the world would feel it too through their own economic slowdown as well as through the world economic slowdown.
I would like to highlight three paramount issues of the current economic recession:
- The first is that the world economy was anyway heading towards a recession even without the COVID-19 issue. The expansion of a gigantic money and credit bubble had already been driving the world economy towards a downfall. This means that, perhaps the COVID-19 epidemic issue came to the world in its worst time, magnifying the potential economic recession.
- Secondly, the world already had a recession in 2008-2009. Since that time the countries were increasingly resorting to both monetary policy and fiscal policy stimuli to get out of the crisis. Whether the global economy recovered from this crisis or not is a source of arguments and debates, while the weak economic fundamentals of some the countries including those of the European Union were exposed by the crisis. The point is, however, the far reaching monetary and fiscal stimuli have raised another issue in almost all the advanced countries as well as in developing countries; extremely low interest rates, high fiscal deficits, and debt burden.
- Finally, the most critical issue is the emerging possibility of bursting the debt bubble with widespread defaults. In fact, it is logically correct that economic crises are caused by growing debt bubbles and, that the recovery is possible with the outburst of that debt bubble. Debt out-bursting means that the values of the debt instruments, particularly the government and corporate bonds, get wiped out, while the borrowers including the governments will be forced to declare defaulting their debt. For obvious reasons, the weaker economies will have to suffer more than the stronger economies.
Debt accumulation was already a major issue, causing the economic crisis in 2008-2009, which led further accumulation of debt through monetary and fiscal stimuli. Finally, the COVID-19 issue has made it even worse because countries all over the world are attempting to accelerate monetary and fiscal stimuli inflating the debt bubble.
Final outcome
In recessions, production activities might come to a standstill, companies and businesses would be closed down, and international trade shrinks. This is reflected by negative rates of GDP growth, as we have already seen for the US, the Euro area, and China for the first quarter of the year. Similar outcomes will be reported by the rest of the world as well. What we have already seen now under lockdown conditions against the COVID issue is the glimpse of a recession.
People lose jobs and work so that they will have less and less income. Different segments of the society begin to feel the pinch of the recession in different magnitudes, while among them there are more vulnerable social groups which quickly fall down after losing livelihoods. This would lead to an increase in poverty and the depth of poverty.
The governments will have to look into the issues of poverty and loss of livelihoods of the people as well as the issues of sustaining the economic activities and businesses, while all these require increased spending. On the contrary, however, the governments will have to face less and less tax revenue exerting pressure on the fiscal operations.
Countries that have already been facing the debt burden and repayment obligations constitute the worst cases. Meeting domestic debt obligations against falling tax revenue and the foreign debt obligation against falling foreign incomes will put these countries in a hard position.
Deceleration of inflation, and probably the worst case of “deflation” – gradual fall in prices – will be another macroeconomic issue emerging from the recession. From an economic point of view, deflation is worse than inflation because, even though some degree of inflation can be warranted, any degree of deflation is harmful to the economic recovery.
V-shape, U-shape and, L-shape
As recessions are inevitable characteristics of the world economic system either for its inherent reasons or for external shocks, the recovery is also inevitable. The question is how long does it take for an economy to end the recession and start moving on an expansionary path.
Recessions are of different shapes depending on the depth and the length of the economic downfall. Some recessions are characterized by a quick fall, and then a quick recovery. While they have the V=shape outlook, some recessions take longer reflecting a U-shape. The worst case of a recession, which is known as “depression” takes an unpredictable long years showing an L-shape.
(The writer is a Professor of Economics at the University of Colombo and can be reached at
sirimal@econ.cmb.ac.lk).