IFC Insights: How to Rebuild From the Shock of COVID-19

By Andrew Mayeda

Mohamed A. El-Erian is chief economic advisor at Allianz, the corporate parent of PIMCO, where he served as chief executive and co-chief investment officer from 2007 to 2014. He is the author of The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse, and warned in 2009 against the onset of the “new normal” of sluggish and insufficiently inclusive growth. Before entering the private sector, he worked at the International Monetary Fund for 15 years, rising to Deputy Director. His first summer intern job was at the World Bank Group while he was a student at Oxford University, completing his doctorate in economics. In this edited interview with IFC Insights, El-Erian predicts a new era of deglobalization that will make it even trickier for developing countries to recover from the coronavirus pandemic.

Q: What is your view on the global economy and emerging markets right now?

A: The global economy right now is on an unsettling journey to an uncertain destination. The unsettling journey is mainly because of the health-related disruptions to economic activity. We don’t know how long this journey will last, and that in itself influences a destination that’s already uncertain. What’s already clear is this challenging environment is not going to be lifted anytime soon for the emerging world.

This is the third major shock of deglobalization in just 10 years. The first shock was driven by the household sector’s pushback against the extent to which globalization had alienated and marginalized certain segments of the population. The second came with the 2017-2018 China-U.S. trade war, which was a government-led shock.

Now, we have a third shock, which involves all three sectors, that is households, governments, and corporates. The corporate sector will join because of a significant shift of emphasis from efficiency to resilience, moving gradually away from long-embraced notions of just-in-time inventory management and cost-effective global supply chains, to more localization of supply chains to make the system more resilient. We’ve entered, in my view, an era of deglobalization. That’s not good for the developing world.

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Q: What does this deglobalization process mean for developing countries? How will it change their development path?

A: The initial conditions for success have changed. If you look at the old world, with the exception of China, because China really is a very special growth model, the initial conditions favored relatively small, agile economies that were open to the rest of the world and able to leapfrog certain growth stages by using external markets and importing capital-enhancing techniques. The one who perfected it was Singapore, but you have other examples, including Korea. In the new world, the initial conditions have changed. You want to be bigger and more self-reliant. You want to be relatively closed. And you want to be able to generate a lot of domestic demand and domestic supply to drive growth.

So, the first thing that has changed is the tilt of the growth model. The second thing that has changed is that, in the old world, people bought into a global system with credible institutions and the rule of law. To the extent that there were abuses in globalization, there was a well-established process for conflict resolution. In the new world, conflict resolution takes place more bilaterally than multilaterally. There is the overhanging risk of weaponizing economic tools. And it puts developing countries at a disadvantage.

Q: One of the challenges in the initial emergency response phase is how to cushion the blow to the private sector. As an economist, what do you think is the right approach?

A: First, it’s very important to do whatever you can to stop liquidity challenges becoming solvency problems. A liquidity problem can be overcome quickly but solvency ones are a lot more problematic. The second thing you want to do is protect the most vulnerable segments of the population that simply don’t have the structural resilience or financial resilience because it’s not just an economic and financial issue. It is also a critical social issue that, if mishandled, can result in increased child labor, child marriage, teenage pregnancy, and domestic violence. Finally, and related to this, it’s important to avoid job layoffs turning into long-term unemployment and a fall in the labor participation rate.

The tough thing is that you’ve got to design this with a view that this is one of three stages and not, to use game-theory terminology, a one-round game. The first stage is focused on relief. There’s two other stages afterwards that you also have to be active in. And you have to be able to transition and make really difficult judgments as to where are you most effective. In doing so you minimize the risk of a one-round approach, opting instead for a multi-round game. I don’t like using the concept of a game because this is far from a game as possible–this is serious. But I have found game theory to be very insightful in thinking about the current situation. For example, we’re very proud of the notions of “whatever it takes” and “all in.” And rightly so. Governments and central banks have really stepped up to their policy responsibilities quickly. But we also have to remember that “all in” has a certain connotation. If you think of poker, “all in” is when you go in with everything you have and others do too. If your “all in” works, you get to walk away from the table significantly better off. But if you lose, you have little for another game. So “all in” is essentially for a one-round game. It doesn’t work well in a multi-round game. It’s very important, in designing interventions, to recognize that there are different phases where countries are going to need a lot of help, and to recognize that you have to phase it accordingly.

And then you need to be asking, what is success? You need clear metrics of success because emergency interventions almost by definition will make mistakes. You are acting in the fog of war. You don’t have sufficient clarity. And you rightly believe that the best can be the enemy of the good. Under all these conditions, there is an inevitably high probability of mistakes. The important thing is to spot them quickly, and course correct as needed.

Q: So how would you describe the three phases?

A: The first stage is relief. In this case, it had to do with the inevitable consequences of a health-dictated lockdown and the sudden economic stop that came with this. A sudden economic stop is familiar to development economists that have worked in failed countries or have responded to big natural disasters. They are really not familiar to most economists. We’ve never seen it at the level of an advanced economy, let alone for the global economy. It reflects in part an unavoidable inconsistency between what the first phase of the public health response calls for, which is social distancing, separation, isolation, and what the economy and society is wired for, the exact opposite. So the damage is intense. The spillovers to developing countries are enormous. The relief effort focuses on getting to the most vulnerable quickly.

The second is the tentative reopening phase. As we reopen without having conquered the virus, we are shifting the pendulum, which initially was set on a normal economy, swung all the way to lockdown, and now it’s swinging back partially toward normal economy, but it has pressure on both sides. If it goes too quickly, lives are at risk. If it goes too slowly, livelihoods are at risk. Or as an African friend of mine put it: “If you go too fast, you risk dying from the infection. If you go too slow, you risk dying from hunger.” That is a very tricky balance to strike. And here, the intervention is aimed at making the reopening as healthy as possible. The third phase is when we have settled at some level where the health and economic risks are balanced as best as can be, community immunity is on the horizon, and it’s about policy stimulus.

Q: So going back to your analogy of the multi-round game, hopefully there will be some chips leftover for the third phase. Is that the idea?

A: Correct. By the way, there’s a real risk for multilateral institutions that there aren’t enough chips.

Q: How important is it for countries to think about rebuilding now?

A: We need to avoid the “new normal 2.0” which, while sharing many of the characteristics of the original new normal, will be worse and a lot less stable. If you look at where the global economy is heading absent timely policies, it will emerge from this tragic COVID-19 shock with lower productivity, higher debt, and more sluggish demand. That is a recipe for even lower growth and higher financial instability. That is the recipe for even greater inequality of income, wealth, and opportunity. That is a recipe for pressures on the integrity of society.

So the stimulus phase has to address the reality that this could be our world absent corrective measures. Now, it’s not a predestined world, because we can change things with good policies, but what it takes first and foremost is productivity enhancement focusing on labor and capital. On labor, there is need for retraining and retooling. We are going to have significant skill mismatches coming out of this, we’re going to have the risk of long-term unemployment. We’ve got to do all we can to make sure that the productivity of labor isn’t hit in a major way. On the capital side, we have an opportunity to modernize and improve our infrastructure. Then we’ve got to bottle up the good things that are emerging from this crisis. Better private public-partnerships is an example.

We’ve got to deal with the reality that certain debt is either already unpayable or will become so. One has to confront it like we did in the 1980s with Latin America and some other developing countries, like we did in the 1990s, with the HIPC initiative for the low-income countries. We’ve got to recognize early the challenge of the debt overhang and deal with it. Already, one of the big lessons of this crisis is that the level of global coordination is very inadequate given the global problems we face, and given the need for shared responsibility.

Q: How realistic is it to expect structural reforms amid this process?

A: A mistake we made coming out of the 2008 global financial crisis is that we won the war against the global depression through amazing global coordination and heroic acts by central banks. But we failed to secure the peace. So instead of emerging into a world of higher growth that is truly inclusive, that is sustainable, and has genuine financial stability, we ended up in this “new normal” of low, insufficiently inclusive growth and artificial financial stability.

Q: Within this context, what do you make of the future of impact investing, i.e., investing with a view toward positive social and environmental impact, alongside financial returns?

A: First I should thank IFC and others, because due to your efforts, you have made this whole concept go from “Let’s talk about it and do very little” to … “Let’s talk about it and let’s do it, not only because it’s the right thing to do, but it is in our interest.” People have realized that sustainability is a key contributor to long-term success. I think a window has opened even wider for this concept right now.


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