Submerged by COVID

Barry Eichengreen February 04, 2022 10:25

The wildfire spread of the Omicron variant adds a new element of uncertainty to the global economy. But when it comes to emerging markets, the consensus view is that these countries’ prospects remain bright. J.P. Morgan Global Research expects their collective GDP to grow by 4.6% this year, faster than its 2015-19 trend. S&P Global Ratings is even more bullish, projecting that emerging economies will expand by 4.8%.

Strikingly, these growth figures are virtually identical to the forecasts for 2022 released by the International Monetary Fund in October 2019 – that is, before the pandemic. It has become a popular trope that COVID changes everything – or, rather, everything except the outlook for emerging markets.

In fact, there are multiple reasons for worrying that this consensus is too rosy.

First, emerging economies are now more heavily indebted. Public-debt-to-GDP ratios were already rising before the onset of the pandemic. But now they have reached alarming heights, at more than 60% of GDP.

While no one doubts the wisdom of borrowing to respond to a public-health emergency and economic crisis, these heavy debts pose management problems. Scarce fiscal resources that might otherwise be devoted to health care, education, and infrastructure will have to be diverted to debt service. And the burden will grow heavier as tighter monetary policy by the US Federal Reserve and capital scarcity worldwide put upward pressure on interest rates.

Moreover, public debt is only part of the problem. Since the onset of the pandemic, the debts of households and nonfinancial corporations have risen nearly as rapidly as the debts of public sectors. It is likely that when some of these private debts go bad, the losses will be socialized and end up on government balance sheets.

The second reason to be skeptical of the consensus on emerging markets is that the risk of working in close quarters has spurred accelerated automation in advanced economies. Because the need for close hand-eye coordination previously frustrated such efforts, the traditional route to higher incomes for emerging markets and developing countries has run through the export of labor-intensive manufactures. Although these industries do not require heavy investments or highly skilled labor, they familiarize workers with factory discipline, enable learning by doing, accustom firms to competing on global markets, and generate foreign exchange.

The fear is that these manufactures will soon be produced by robots and 3D printers in the same high-wage countries where they are sold. This prospect reinforces established concerns about “premature deindustrialization” in emerging markets.

Relatedly, the global supply chains so important to emerging economies experienced major disruptions because of the pandemic, leading firms to source inputs closer to home. Developed-country governments, for their part, have cited shortages and economic-security concerns as justification for creating incentives for firms to onshore more manufacturing production.
For emerging markets, the negative effects are not unlike those of accelerated automation. Many low- and middle-income countries start with simpler assembly tasks before moving into more sophisticated manufacturing operations. These opportunities will be fewer to the extent that advanced economies do more assembly at home.

Mexico may benefit from efforts by US firms to shorten their supply chains. Eastern European economies may benefit from an analogous desire on the part of EU countries. But South Asia, Africa, and Latin America may find themselves cut off.

Above all, there is the impact of COVID-19 on human capital formation. Though negative everywhere, the effects are likely to be especially severe in emerging markets. Few emerging markets possess the high-speed broadband needed for effective distance learning. A slower pace of vaccination will mean continuing school closures and absenteeism. According to an estimate by the World Bank, the share of children in emerging markets and developing countries unable to read and understand a simple text by the age of 10 will increase from 53% to 63% as a result of the pandemic.

The most powerful counterargument is that emerging markets will benefit from a supercharged global economy. Productivity growth in the advanced economies, which had been trending downward for several decades, was strong during the pandemic, especially in the United States. Technological and organizational changes prompted by the pandemic could now sustain that acceleration. Faster growth in developed countries would then create additional demand for emerging-market exports.

At this stage, this argument is purely hypothetical. The recent pickup in advanced-economy productivity growth is entirely attributable to business-cycle factors – most recently to firms using their resources more intensively as economies bounce back from their 2020 lows. In fact, the productivity trend looks much like it did in earlier cyclical recoveries – meaning that there is no evidence of a durable acceleration.

But all is not doom and gloom. In contrast to earlier downturns, central banks and governments in emerging markets have been able to respond in stabilizing ways, reflecting their success at building credibility. So far, the bank failures and financial accidents that historically punctuated such episodes have been few and far between. Vaccine production and administration are ramping up. That said, downward revisions of growth forecasts are almost certainly coming.

Copyright: Project Syndicate
-- Contact us at [email protected]

Barry Eichengreen

The writer, a Center for International Governance Innovation fellow, is a professor at the University of Cambridge and the University of California, Berkeley.