The coronavirus has hit the world economy at a time when many economies were slowly going into recession. The tariff war between China and the United States had already led to a disruption of global trade and was causing an economic slow-down for many countries.
The world economy is now teetering on a knife’s edge: the Chinese economy has slowed down, the Indian economy has already slowed down with the antics of the Modi government, and Italy, like many other European countries, is on lockdown and likely to plunge into a recession.
Share markets have gone through some of the worst collapses since the 2008 Great Recession. Tourism has been hit significantly, and airlines are either at risk of going bankrupt or cutting back significantly. What are the likely outcomes? What is to be done?
In the short term, the world will witness a recession with increasing unemployment and long-term unemployment. If governments introduce stimulus policies, the economies should begin to stabilize in the medium term, while in the longer term, they should come out of recession.
Supply and Demand Shocks
The world is facing its worst crisis since the Great Recession of 2008-2009. The World Health Organization has declared coronavirus a pandemic. Panic has set in many countries, with long queues at shopping malls and pharmacies for face masks and hand sanitizers.
As China is a major player in the global economy, both as an importer and exporter, a recession there has hit many economies that not only sell products to the country but also buy intermediate products that enter the supply chain for industrial production in the U.S., Europe, and Pacific nations like Australia. Global uncertainty has escalated and is strangling business investment in real capital goods.
World tourism has been drastically reduced with airlines and the cruise industry suffering. Insurance companies and banks may come under stress and might go into bankruptcies as the virus spreads. A financial crisis may ensue.
The world is facing a different crisis than the financial crisis that sparked the Global Financial Crisis some twelve years ago. At present, the world faces both a supply shock and a demand shock. Global production is being disrupted, and the demand for goods and services is declining rapidly as employment falls and unemployment jumps up.
Descent Into Recession
All the evidence available so far points to many countries having begun a descent into recession. It is, however, unclear how long this recession would last and whether the recovery would be rapid or long drawn out.
As it happens, many of the global economies had already been slowing down with monetary authorities lowering interest rates to historic lows. In some European countries, nominal interest rates were even negative. Hence, the usual response of lowering interest rates is unlikely to prevent the recession. The U.S., U.K., and Australia have all cut interest rates, but this is not likely to stimulate investment expenditures by firms as there is too much uncertainty.
To tackle the coronavirus crisis, a concerted global response is needed. Clearly, if all major players decided to stimulate their economies at the same time, we would be able to prevent the recession from being a deep and lasting one. But this requires not simply lowering interest rates and “quantitative easing” but significant fiscal stimulus packages being introduced simultaneously.
Easing the Pain
To ease the pain of this recession, fiscal policies need to be introduced to stimulate the economy immediately. Ideally, there would be a big stimulus package that increases the post-tax income of low-income households and the welfare benefits of unemployed people, old age pensioners, and the sick.
This means that income taxes for low-income groups should be lowered, unemployment benefits should be increased, and cash payment should be provided immediately to all low-income households (including the unemployed).
Given the spread of the virus, governments must spend on public health facilities, support workers who are forced to quarantine themselves, and provide income support to those who are forced to work part-time or become unemployed.
To avoid the recession continuing for an extended period, public investment in infrastructure projects – such as schools, hospitals, housing for the homeless, and aged care homes – must be increased.
This time it is different. This global crisis is not triggered by a financial breakdown but by a collapse of trade and travel due to a pandemic. It needs a concerted global response by governments. If we manage it well, the recession may be short-lived.