In this column, I pose seven questions about the Covid-19 pandemic and its consequences:

• What is the nature of the Covid-19 shock?
• What are the consequences of and immediate responses to Covid-19?
• Are lockdowns sustainable?
• Can all countries do ‘whatever it takes’ to deal with the pandemic?
• How should countries prepare for a recovery?
• What of global supply chains and trade?
• What of sovereign debt restructuring?

1.    What is the nature of the Covid-19 shock?

The novel coronavirus that causes Covid-19 has spread to all continents since Chinese authorities first reported it to the World Health Organization (WHO) on 31 December 2019. Most countries, whether considered advanced or developing economies, are still struggling with a large number of infections and the consequent economic and social fallout.

The Covid-19 crisis is one of preparedness (or lack thereof) in health, administrative, and strategic capabilities. The crisis has exposed further social and economic fault lines in both advanced and developing economies. There are three fault lines that are especially consequential for developing countries in the Middle East and Africa:

• Low social and fiscal buffers. In 2019, protests rocked the Middle East and Africa, and in turn spread globally. They receded with the imposition of confinement measures to slow the spread of Covid-19, but are picking up again. These protests stem from distrust of government, which complicates handling the health and economic crises associated with the pandemic.
• Dual and polarised labour markets. Most workers in developing countries, including those in the Middle East and Africa, work hand-to-mouth in the informal sector. In advanced economies, the polarisation is between high- and low-skilled workers in the formal sector. Following confinement measures, tensions emerged in advanced economies as low-skilled individuals could not work remotely and hence faced more risk of being furloughed, laid off or exposed to the virus in the workplace than did high-skilled workers who could work from home more easily. Confinement measures to prevent the spread of virus have thus increased poverty and exacerbated inequality in both developing and advanced economies, even though richer countries could provide more cushion.
• Lack of fair competition. Many developing countries, including those in the Middle East and Africa, suffer from both crony capitalism and large state-owned enterprises (SOEs) that are major employers. Both have outsized access to markets and credit, and crowd out small and medium-sized enterprises (SMEs), which forces a large portion of the workforce into the informal sector. Many of the SOEs in developing countries barely cover their debt costs and have limited capabilities. These so-called ‘zombie firms’ make it virtually impossible for economies to innovate their way out of the crisis. While advanced economies start from a much higher level of competition, they exhibit a decline in competition related to the rise of digital giants and other network industries. The risk of zombification of firms in advanced economies is high given the pandemic’s effect on a scaling down in demand prospects and large indebtedness.

There is great uncertainty about the transmission, mutation and other aspects of the novel coronavirus. The pandemic-spawned crisis is like no others. It started with a supply shock – production slumped as workers stayed home – and was followed by a demand shock as income sagged among unemployed or underemployed workers.

The scenario is unlike those of the Global Recession of 2008 and the Global Depression of 1929 – which were triggered by financial meltdowns, which spilled over to demand and required stimulus. The Covid-19 shock requires relief merely to preserve and protect consumption and production capabilities for the time needed to eradicate the disease.

2. What are the consequences of and immediate responses to Covid-19?

Covid-19 and the associated measures to contain it have brought the global economy to a standstill. The International Monetary Fund estimates that the pandemic will cause global GDP to decline by 4.9% in 2020 – 1.9 percentage points below its April forecast, and 8.2 percentage points below the January forecast.

As the spread of infections appeared to slow down, containment measures were eased in advanced economies, but the result often was a resurgence of infections. Developing countries seemed for a while to have been spared the worst of the pandemic – even after limited testing was taken into account – but many now are experiencing a surge of infections from the highly contagious virus.

Developing and advanced economies have been affected directly through illnesses and deaths, but the pandemic has also hurt developing countries indirectly through several channels of transmission:

• Capital outflows and financial instability. Capital has fled many developing countries for what investors perceive as safer assets in advanced economies. These outflows have disrupted exchange rate and financial markets in developing countries and emerging markets. Foreign direct investment (FDI) has also plummeted, reflecting investor wariness about the future. In the Middle East and North Africa, FDI from January to May 2020 was half what it was during the same period in 2019.
• Disruption in trade and global supply chains. Concerns about security of access to key pharmaceuticals, medical equipment and food have led to hoarding, which has created shortages and rising prices. That has led to calls for repatriation of production of key equipment.
• Lower oil prices. The Covid-19 shock has been associated with an extraordinary collapse in oil prices. The collapse has both a supply and demand component. Demand for oil is estimated to have declined as much as 20 million barrels per day because of reduced transport requirements (land, sea and air). The re-opening in emerging markets – especially China – has rekindled demand for oil. Prices were hurt further on the supply side because of a breakdown in a production restriction agreement between the Organization of the Petroleum Exporting Countries (OPEC) and allied but non-OPEC producers in March 2020. But output has been more restricted recently, and oil prices, which fell to as low as zero on futures markets in May, have rebounded to about $40 in July 2020.
• Drops in tourism and remittance flows. Closing of borders and confinement measures have limited the movement of people. Remittances are projected to drop by 20% in 2020. Receipts from international tourism are also expected to drop dramatically. For some countries, including some in the Middle East and North Africa, tourism can be important. It was the equivalent of 25% of exports in Egypt and 41% in Jordan in 2018.

In response to the pandemic, countries not only took blanket steps – such as lockdowns and closing borders – to limit the spread of the virus: they also undertook economic actions to preserve consumption and protect production capabilities. More recently, countries have attempted to move away from blanket instruments by providing more selective relief and taking steps to ensure that relief reaches its intended targets.

The blanket measures to contain the virus spread led to reduced domestic activity and trade. They were meant to buy time to minimise the risks of infections and death. More targeted interventions such as contact tracing and targeted confinement will allow authorities to keep the virus at bay until a vaccine is developed.

Developing and advanced economies used fiscal and monetary policy measures not only to finance the health response to the virus, but also to forestall a collapse in consumption, and to protect the economic fabric – including SMEs. The policies are also aimed at avoiding mass unemployment by subsidising employers who keep workers on the payroll and by expanding unemployment insurance.

The health and economic responses are intertwined. The quality of the health response towards containing the virus will determine the sustainability of the economic recovery.

3. Are lockdowns sustainable?

Addressing Covid-19 is a case of decision-making under uncertainty. The novel coronavirus is highly infectious, unknown before late December and shows some evidence of mutation. The precautionary principle justifies lockdowns. But is a 14th century solution used against the Black Death a proper response to a pandemic in a modern information society? The answer is ‘yes’ in the short run.

Lockdowns were imposed to buy time to develop more targeted, less-disruptive approaches – the so-called three ‘ings’ of masking, testing and contact tracing. Armed with information technology, authorities can target potentially infected people and isolate them in specialised facilities when home quarantining is not feasible.

Hong Kong, Singapore and Taiwan relied on their experience with highly infectious diseases, such as SARS, and imposed targeted confinement measures coupled with technological advances in contact tracing. They seem to have largely contained the disease, even though there have been localised resurgences.

In both advanced and developing countries, Covid-19 has tested strategic public sector capabilities and the ability of the public sector to collaborate with the scientific community.

At the global level, Covid-19 presents a challenge to medicine. There are several avenues that could help to slow or stop the virus:

• Antivirals, which stop the virus from replicating. The drug remdesivir has shown some efficacy in this area.
• Indirect therapy, such as helping with breathing. That is important because Covid-19 is often accompanied by respiratory failures.
• Immune therapy, which injects infected patients with cells from people who have recovered. The therapy is experimental.
• Vaccines. Vaccines provide the safest and quickest way to achieve so-called ‘herd immunity’. It typically takes a year or longer to develop an effective vaccine, if one can be developed at all. But governments and companies are trying to develop and deploy a vaccine in less time. There are more than a hundred vaccines under development.

In the future, the international pricing of medicines and patenting issues will be particularly important for developing countries, which will be buyers of any pharmaceuticals. There is a need for a global approach to eradication to avoid the weak link problem, in which there are countries or regions in which the virus persists.

The global eradication of smallpox and polio, for example, was hindered by such weak links. Indeed, taking care of all the communities at the domestic and global level – especially the poorest, such as low-skilled expatriates, or refugees living in camps or informal settlements – is essential.

The issue with controlling pricing is one of private sector incentives. Production capabilities in the private sector can be high, but profit incentives for R&D and further development can be inadequate. It is a delicate balancing act to provide sufficient incentives but at a level that avoids excessive profits and keeps prices low enough to enable poor countries to afford the treatments. Coordination at the global level is needed including to fund the large purchase orders of vaccines for poor countries.

4. Can all countries do ‘whatever it takes’ to deal with the pandemic?

In the face of such an overwhelming crisis, many have rightly called for doing ‘whatever it takes’ to stem the advance of the disease and mitigate its economic consequences. Because they can borrow in their own currencies at low interest rates, most advanced economies have used fiscal and monetary policies to finance the health response, provide relief to businesses and people, and inject liquidity into their financial systems. Where inflation is not an issue, helicopter money (essentially printed by a central bank) has been used, as has quantitative easing and direct purchase of sovereign debt by central banks.

Developing countries, on the other hand, face massive constraints on their ability to do whatever it takes to stop the spread of the virus and provide relief to their people – many of whom work hand-to-mouth in the informal sector. What is more, the poor in developing countries are disproportionately affected by infectious disease, so the need for government intervention is not just for efficiency but also for equity.

To finance efforts to contain the virus, avenues such as raising taxes, printing money or borrowing are limited in developing economies. Because of the prohibitively expensive borrowing costs that most developing countries face in international markets and the already high level of debt denominated in foreign currencies, the international community plays a critical role.

5. How should countries prepare for a recovery?

The pandemic-spawned decline in disposable income and rise in precautionary saving imply that consumption dropped. Demand for big-ticket items like housing and cars as well as external demand for hospitality and transport has been reduced.

So has peak oil demand. Production has dropped because of lockdowns and is being hindered because of cost increases triggered by the disruption of global supply chains and more localisation and reshoring. Further costs increases may arise from workers more likely to demand higher salaries and dignity/hazard pay. Reshoring is likely to be accompanied by increased automation, which means bringing back production from overseas will provide more limited employment benefits than advocates promise.

Moreover, it is unclear whether inflation will rise. The pool of unemployed workers is increasing, which reduces the lowest wage at which workers will take a job (the so-called reservation wage). But high unemployment is likely to result in a minimum wage increase, a universal basic income and a universal social layer in which healthcare insurance is no longer tied to employment. The available evidence suggests that there is no adverse impact on unemployment from an appropriately set minimum wage.

Forecasters have been overly optimistic about recovery prospects – projecting a quick bounce back, or V-shaped recovery, to a slower U-shaped rebound, to a series of recoveries and recessions, that is, a W-shaped economic future. There are many factors, but the status of public health is overarching. That means the first order of priority is getting the health response right.

It is imperative to avoid the risk of depression – and the permanent scars on consumption and production capabilities that it would bring. Employment insurance to protect consumption can be designed in different ways. In the European Union, the scheme aims at preserving the link between employees and employers. In the United States, unemployment insurance is paid directly to the jobless individual. Countries have also eased credit access to reduce the risk of a firm’s illiquidity turning into insolvency.

To prepare for the recovery, it is useful to think in terms of three concentric circles that can serve as a reference in determining whether bailout, support or inaction is the best response:

• Circle 1, which requires a bailout if needed, includes network industries (electricity, telecoms, and banking and finance) as well as transport and distribution.
• Circle 2, which calls for support with easy credit, includes tourism, restaurants, the hospitality industry, the industrial sector, and the food sector.
• Circle 3, which should elicit no support, includes downstream communication, gaming and streaming.

The saying ‘never let a crisis go to waste’ is particularly apt for this one. Indeed, opinion surveys show the impetus to rebuild is widely shared whether it is about the environment, social solidarity or digitalisation. Could the Covid-19 pandemic be a Schumpeterian moment that forces society to address such longstanding issues as lack of competition, especially in developing countries?

The pandemic is an opportunity to set off an innovation tide to help renew productive capacity. To achieve that, it is important to reform the business environment by say, activating unenforced bankruptcy laws or organising so-called out-of-bankruptcy workouts that would eliminate some bailouts by transforming corporate debt into equity. An agency was created to do that in the United States after the global financial crisis of the past decade.

The productive capabilities in many developing countries, such as those in the Middle East and Africa, are limited because of business environments that encourage rent-seeking, import dependence and under-used accumulated human capital. Large segments of the labour force are in the informal sector and the rest are in the public sector, including large SOEs. The crisis is an opportunity to reform SOEs and public service.

That reform will allow authorities to send home many public and SOE employees, while supporting their consumption through a universal basic income. There is a need to move away from fragmented social protection, substituting a universal social layer. Universal basic incomes could be financed by a wealth tax or housing tax, and by a tax base that is bigger because informal firms and workers join the formal economy.

Universal income can also be financed through the eradication of corruption and inefficiency that stems from a market structure geared towards rent-seeking. For example, the strongest lobby against efficient domestic production comprises those who own monopolised import licences.

To boost the productivity of SMEs and the informal sector, interventions are required on both demand (access to markets and credit) and supply (reinforcing entrepreneurial capability and access to technology) sides.

The crisis has highlighted the importance of digitalisation for such efforts as contact tracing. In some countries, where the infrastructure of both telecommunication and digital payment is underdeveloped, removing barriers to entering and leaving markets by reinforcing regulator prerogative is paramount.

Indeed, given the expanding consumer base in many developing countries, the growth sectors are service activities conducted through platforms. These platforms can help to disrupt stodgy existing logistics, transport and distribution, and, by doing, so foster trade.

It is imperative to strengthen the competition apparatus across the board and promote regionalised competition authorities to get around roadblocks posed by local politics. To do so, governments must agree to empower sectoral and regional regulatory bodies with independence and accountability.

The crisis also constitutes an important antitrust moment for developing countries. Issues surrounding mergers during the crisis will be particularly important, because mergers may reduce competition and consumer welfare and job creation.

6. What of global supply chains and trade?

The Covid-19 crisis raises the question of whether globalisation has peaked. As with digitalisation, the pandemic has accelerated trends such as decoupling supply chains, nationalism and reshoring – which have caused a slowdown in trade. The dislocation of global supply chains is already well underway.

The strategic rivalry between China and the United States and trade wars are behind these trends. The pandemic will likely accelerate the re-wiring of global supply chains because multinational corporations will need to add layers to ensure they are not vulnerable to shocks. Global supply chains account for half of global trade.

While the size of China’s domestic market remains appealing for multinational corporations, the desire to reduce reliance on one source of product will lead to more regionalised supply chains. There is also push to localise strategic industries such as pharmaceuticals, agro-industry and technology. Research suggests that growth benefits from trade related to global supply chains are three times larger than regular trade.

To take advantage of the opportunity provided by relocalisation, countries in the Middle East and Africa should both improve their business environments and pursue regional integration. They need to regionalise their competition and regulatory agendas. They could also consider a regional digital regulator. It would be difficult politically but worthwhile. Regional regulators have the best chance to unlock the full potential for developing countries.

The digital response to home-based work that resulted from the pandemic has been impressive in advanced economies, but also in developing countries. Yet, poor internet quality in developing countries risks accentuating the digital divide. Again the pandemic has accelerated trends towards small retailers selling online, distance learning, video conferencing, video streaming and gaming.

The strategic rivalry over 5G technology between the United States and China confronts countries with a choice between the two superpowers. Contact tracing of individuals exposed to the virus has revealed more privacy issues from digitalisation as companies such as Apple and Google lead the charge on a technology-based response to Covid-19.

The pandemic will accelerate the transformation of many sectors because of changing demand prospects. Companies will increasingly use more technology – such as digital payments and digital banking. In the hospitality and transport sectors, passengers will have to be screened, requiring rapid testing, masking, and revised regulations on airline carryon luggage.

It is likely to be several years until tourism returns to normal, but countries adhering to high standards of health and sanitation will be likely to experience a faster recovery. Indeed, it will be paramount for companies to maintain consumer confidence.

7. What of sovereign debt restructuring?

Sovereign debt will increase in all countries. In most advanced economies, sovereign debt will grow by about 20% of GDP. That will prompt a rethinking of debt sustainability analysis, which often favours reduction of debt levels at the expense of growth.

There will be more debt resulting from corporate restructurings. While banks were adequately capitalised prior to the pandemic, if households massively default on mortgage payments or rents, non-performing loans will increase – potentially creating fragility in the banking sector that would have serious consequences for the rest of the economy and sovereign loans. Most advanced economies will have to choose between inflating away debt and raising taxes, including on wealth.

In low- and middle-income countries, the inability to repay debt has led to calls for forbearance on debt service. A much welcome debt relief initiative championed by the Group of 20 relied on bilateral official creditors postponing debt repayment. Bringing in private creditors will be critical to ensure that the funds freed up by official forgiveness are used to help economies rather than used to pay private creditors.

Moreover, much more debt easing, whether restructuring or cancellation, will be needed to prevent a debt overhang that would obstruct recovery and limit growth prospects of developing economies.