Authors: Adam Triggs, ANU and Homi Kharas, Brookings
Every G20 Summit host is warned that all the careful planning can be overturned in an instant by a global crisis. Saudi Arabia’s planned agenda is now being pushed aside to make room for an emergency G20 leaders’ meeting in the coming days to deal with the COVID-19 (coronavirus) pandemic.
There is a perfect storm brewing in the global economy. Most recessions are caused by a demand shock (think 9/11), a supply shock (think oil price increases) or a financial shock (think GFC and Lehman Brothers). COVID-19 promises to deliver all of the above in a single wallop.
The demand shock is clear — whole populations are in quarantine. A large (5 to 10 per cent of GDP) decline in the next quarter is expected. Equally, the supply shock is widespread. As Geoff Gertz has noted, the real threat is that we do not know the potential production choke points as the mapping of supply chains is opaque. Finally, the recent actions of the US Fed to inject US$500 billion into repo markets suggest a liquidity crunch. Many small and medium enterprises will likely default or have to reschedule bank loans.
The G20 must act on all three fronts simultaneously to have impact.
First, leaders should announce a coordinated fiscal stimulus package to address the demand shock. The impact of fiscal stimulus can be up to twice as large when it is coordinated across the G20 because when any country operates on its own, there is demand leakage into imports that reduces the effect. Ideally, leaders give a one-shot direct cash transfer to households, particularly poorer households who are more likely to spend the money.
Having a collective G20 commitment also results in countries doing more stimulus than they otherwise would have done. Interviews with G20 leaders, ministers, governors and senior officials show this was true in the GFC. Many used the G20’s commitment as political cover, sending a vital message of confidence to markets and boosting global aggregate demand. This is especially important today when voices against higher government debt are louder.
Second, leaders must reiterate their long-standing commitment to avoid competitive exchange rate devaluations. Research shows that competitive devaluations can spiral into full-blown currency wars.
Third, there must be a collective commitment to keep global supply chains open to address the supply shock. This includes providing small and medium enterprises access to credit. Additionally, leaders should commit to not introducing any new restrictive trade or investment measures, including under the guise of a health response.
Naturally, the most important supply chain in the short run is that for medical equipment. Since the beginning of 2020, 24 nations have imposed export bans on medical equipment. The G20 should publicly commit to scrapping barriers on imports of relevant medical equipment, soap, disinfectants, and medicines, agree to reverse and discontinue all export bans and incentivise private suppliers through minimum price guarantees.
Fourth, leaders must commit to ensuring the adequacy of the global financial safety net. The COVID-19 shock is transforming into a financial crisis. Tightening financial conditions could cause serious balance of payments problems in fragile economies.
Research shows that the safety net is dangerously inadequate at present, unable to provide even the same level of financial support as was provided in previous crises such as the Asian financial crisis. There is little understanding of how the IMF, bilateral swap lines, regional financing mechanisms and development banks would be coordinated during a crisis.
Addressing the safety net’s inadequacies will be critical to stopping economic contagion. G20 leaders must commit to increasing the IMF’s resources. The fastest way to do this is to extend and enlarge countries’ bilateral loans to the IMF, which will expire over the next two years. Expanding the use of the IMF’s precautionary lending — where it lends to countries before a crisis has occurred — will ensure fast responses, minimising the cost of crises, but it will also require substantial IMF resources.
Leaders should direct the IMF to urgently increase planning and coordination with regional financing mechanisms, such as the European Stability Mechanism and the Chiang Mai Initiative Multilateralization. This is because even with increased resources, the IMF will likely be a minority lender.
At the same time, international financial institutions must be encouraged to provide the resources to permit governments in developing countries, to have the same kind of fiscal space as other economies. During the 2008 crisis, low-income countries were unable to expand fiscal spending and their safety nets and social assistance programs correspondingly suffered. The same should not happen again.
The world is a different place from what it was in 2008 and it faces a very different, bigger shock. More limited macroeconomic firepower is worrying, but the greatest concern is the deficit of international cooperation that has emerged since then. Success in addressing COVID-19 will only be as strong as success in the weakest country. Germany may eradicate the virus, but if Italy drops the ball, it will be back within days. Global cooperation is therefore vital. This is why the G20 was created. Its leaders now need to rise to the challenge.
Homi Kharas is Interim Vice President and Director of the Global Economy and Development program at the Brookings Institution.
Adam Triggs is Director of Research of the Asian Bureau of Economic Research (ABER) at the Crawford School of Public Policy, The Australian National University, and a non-resident Fellow in the Global Economy and Development program at the Brookings Institution.
A version of this piece originally appeared in Future Development, Brookings.