The post-COVID world: more debt and lower long-term growth

The appearance of this “black swan” has generated an unprecedented shock in the global economy that has resulted in a sharp fall in activity levels. It has been characterized as totally unique due to its exogenous, global and unpredictable nature.

This is a self-imposed external shock due to preeminently health-based decisions and measures (i.e., lockdown and social distancing) that have led to disrupted activity through restrictions on social interaction in both developed and emerging economies. This shock will have different kinds of effects. In the first instance, it will have direct effects on supply and demand, which have led to the collapse of activity and expectations (due to uncertainty). Secondly, and depending on the extent to which social lockdown measures are finally adopted, these measures will lead to a deterioration in agents’ income, growing pessimism among industries and consumers, with both groups facing increasing liquidity problems. And, finally, the third type of effect of this shock relates to the long-term, in the normalcy that will be imposed by the incomplete recovery that lies ahead, which may translate into sovereign and financial solvency problems, distortions in the price of assets, reduced capacity for long-term growth (lower physical capital, human capital and productivity) and high public debt, among other aspects.

Second, this is a global shock that will bring GDP down in 90 percent of the world’s economies. The effects will vary, conditioned by the productive structure of each country and by the economic and health vulnerabilities of each system. In terms of GDP, the shock will lead to a very significant correction in the baseline scenario of around –5 percent in 2020, with significant differences between regions. It will raise the level of unemployment globally (the International Monetary Fund estimates that 400 million jobs will be lost) and widen the poverty gap. In terms of disposable income, the expectation is for a widespread reduction of the increased levels of prosperity built up by the middle classes since the beginning of the millennium, especially in Latin America.

In terms of financial effects, the shock may involve current-account financing problems in many emerging markets, exerting pressure on their exchange rate and depleting their reserves. It may also distort the price of many safe-haven assets (gold, sovereign bonds, etc.) and may alter international investment preferences by virtue of a growing crowding out effect. Furthermore, the shock will favor the persistence of an environment of financial volatility and fragility, distorting the correct functioning of markets due to the effects of the crisis per se and also to the measures taken by governments and central banks to contain it.

Thirdly, the very nature of this economic crisis means that uncertainty is high (which can be seen in the confidence level of producers and consumers) and also transcends the perception of global risk and its regional derivatives (VIX and EMBI). This phenomenon is noticeable in the management of global portfolios and in the mass migration of flows experienced since the beginning of the pandemic, in line with the rise in the emerging risk premium, altering net portfolio inflows in countries that are of key importance for financing their current account. Risk aversion currently remains high, although it has eased, and financing flows stand at the level recorded in April, with their deterioration being largely halted thanks to the action of central banks in developed countries. Furthermore, in addition to this uncertainty, it is also possible that new risks will appear that we are currently unaware of, but which may be caused by the interaction of pre-existing risks and the crisis triggered by the COVID-19 pandemic.

The timeline of the development of the crisis caused by the COVID-19 pandemic can be understood in two phases. Firstly, a containment phase (during the second and third quarters of 2020), which was initially marked by social distancing and lockdown measures. During this phase, shocks affected global value chains, there was limited demand—especially for services—and high uncertainty, leading to increases in the savings rate and a fall in consumption. However, as restrictions eased and monetary and fiscal economic policy began to show effect, the situation improved to the point where, in general, the initial forecasts for economic growth for 2020 were revised with greater levels of optimism.

Secondly, there would then be a transition phase (which would extend from the last quarter of 2020 and last throughout 2021), during which the world would enter a second wave of infections, with an increase in the number of coronavirus cases and a consequent return of restrictions, with mixed effects on global activity depending on the corresponding specializations and renewed levels of pessimism among consumers and producers. This would take place in an environment with reduced monetary and fiscal leeway for the application of public policies and thus a lower capacity for positive surprises in the future.

In conclusion, my vision for what may happen beyond 2021, without going too far in terms of pessimism, is that we believe that the future will be dominated by three elements of the new normalcy: (i) substantially higher levels of debt; (ii) lower long-term economic growth and (iii) a lower level of participation on the part of the market economy in favor of the greater influence of the public sector and the central banks.