The Global Economy in the Post-COVID Era

Introduction

In a world where the policy responses to COVID-19 vary from indifference to economic shut-ins for weeks and months at a time, the result is an economic reality that feels akin to wartime disruption.

The nature of the COVID-19 disruption is utterly unique. Some sectors of the economy are closed down or severely restricted while others are left to work as they see fit. Because of interlinkages between economies, only a modeling system capable of allowing for the interindustry links as well as global linkages to manage some of the impacts and assumptions outside of economic factors can offer the possibility of projecting the economic effects.

Quantitative Economic Research International (QuERI) offers one such model, with a sector specific approach that may be better suited to analyzing the effect of a government induced shutdown and reopening of economies. General adjustment factors in the QuERI model are developed based on the degree of virus and the stage of development to disturb the model’s baseline (December, 2019) result.

In this article we consider the long-term effects of the COVID-19 pandemic through a macroeconomic lens, including adjustments to gross domestic product, private consumption, business investment, government expenditures, exports and imports, as well as financial variables, including prices, exchange rates, and interest rates.

The Pandemic is a Unique, Partially Self-Inflicted Economic Event

The economic impact of the pandemic reflects how economies worldwide functioned under varying policy responses. Governments in wealthier economies used a variety of income maintenance plans, ranging from enhanced unemployment payments to paycheck protection programs through employers in the form of forgivable loans to small, medium, and even large industries. In some areas of the world, notably Asia, cultural and government factors supported more limited shutdown scopes and for shorter intervals.

We’re in the beginning stages of unraveling how these deviations in pandemic response will play out globally over the next few decades. While there have certainly been bumps in the road to stable long-term growth for the world economy over the past three decades, a relatively stable global growth trajectory was established near or exceeding 3%, bolstered by growth across a group of emerging markets. If not for the pandemic, the world economy of 2017 was on course to grow by more than 34% by 2030. QuERI model’s estimates show that in the post-COVID scenario by 2030 the world economy is now expected to increase by 29.8% compared to 2017.

As you’d expect, we have to look at the world’s largest economies to have any hope of understanding QuERI’s global economic growth projections.

China. Despite the fact that China suffered the first effects of the virus, for many reasons, not the least the ability of a more authoritarian government and the willingness of the populous to follow orders, the impact has been less severe. QuERI’s model suggests that while China’s growth will decelerate to 4%, a two percentage point decrease compared to the pre-COVID period, real growth of 2.8% is feasible and even probable for the full year 2020.

United States. What sets the United States apart from the other countries and regions? For the most part the  pandemic has been felt most severely in the services sector, which represents 86% of total US jobs compared to just 29% in China. Among advanced economies, excluding the United States, services sector employment makes up 80% of jobs; the figure drops to 71% for emerging markets (excluding China) and developing countries. It’s not surprising then that value-added (represented by GDP) showed a deeper decline in 2020 in the United States.

Monetary & Fiscal Policy in the Post-COVID World Economy

The post-COVID period will require monetary authorities to work closely with governments to help the recovery. As for fiscal policy, it will err toward expansive to speed recovery from the economic collapse experienced in 2020. Let’s tick through a few of the levers that policymakers will use and monitor.

Inflation and interest rates. With inflation trending flat to down, short term lending rates will run low in parallel with inflation rates for a long time to come, a trend expected across advanced, emerging, and even developing countries.

Exchange rates. The QuERI model predicts a steady but small devaluation of the US dollar as European and Japanese rates appreciate slightly. At the same time China’s currency will appreciate, while other emerging market and developing country currencies will continue to depreciate relative to domestic inflation.

Wages and labor productivity. Nominal and real wages highlight differences between advanced country wages and those of emerging and developing countries. Of note for workers, however, is that the QuERI forecast calls for real wages to increase at rates that are generally consistent with increases in output per worker (full factor productivity), which would be a natural economic boon.

Productivity improvements in emerging markets have significantly eroded the advantages of building products in advanced countries. Factories in China are often more efficient and even more automated than in Texas or France. This trend in improving productivity per worker suggests that in a choice between building capacity in China or Texas, worker productivity will become the deciding factor.

Economic Drivers of Global Growth and Development in the Next Decade

Consumption was the primary driver of economic growth for advanced economies between 1990 and 2000. That’s about to change. The rebalancing of economic drivers in emerging markets will be the most important macroeconomic event of the next decade.

Over the next three decades, the US economy will remain consumption oriented, while other advanced countries will turn to international trade. In the United States, even a small increase in the export share of GDP is overwhelmed by the surge in the import share, reducing the domestic economic growth rate. There is no simple or cost free way to change this.

The pandemic magnified this dynamic: Once COVID lockdowns largely ended and direct subsidies to consumers replaced wage income, US imports continued to expand and replaced at least some domestic supplies. Any effort to reboot the US economy without preference to domestic supply over foreign will reinforce current patterns that the QuERI model shows are embedded deeply into the economic DNA of the American economy. The key question will be how long the US economy can grow as a result of buying more from the world and selling less given the already high level of personal wealth and consumption in the country today.

The mirror image of this shift is already being seen in China and other emerging countries. The share of consumption in GDP increased dramatically allowing the standard of living to increase in emerging markets. Investment powered growth in these markets initially (~1990 through 2010), but as wealth increases the share of investment naturally declines as consumption takes on an increasing share in the economy.

The shift in importance of trade to internalized growth will come from emerging market consumers with incomes powered by a rising real wage. This rebalancing is critical to sustained growth and the dynamics implied within the QuERI model suggests it will happen, but as we have indicated, the rate of growth within this group given that they are already reaching critical mass will necessarily slow so that the gap between rich and poor will close only partially.

Global Trade Imbalances Will Remain

Global trade imbalances will not only likely remain, but the data suggests they will grow and the world trading system will remain a risk to the long term stability of world order.

Global trade imbalances are not so simple as any one country ‘unfairly’ trading. Industrial investments concentrated in select countries and regions have created trade imbalances that distort the market clearing mechanism so that these imbalances remain barriers to accelerating the development of poor countries and even other emerging markets.

More alarming, massive surpluses on the part of Germany, the Netherlands, Japan, and even Italy will only lead other countries to question the benefits of low tariffs and open borders. Germany and Japan continue to run growing surpluses based on the pattern of global demand for technologically sophisticated products and these countries’ reputations for supplying quality products. But, looking ahead, based on the mix of industries and the QuERI model’s global allocation of supply and demand:

  • Italy runs a growing surplus within the advanced country group,
  • The United States remains a major importer and deficit trade country,
  • China slides into deficit with the other emerging markets trending slightly positive, and
  • Developing countries remain in deficit territory.

Let’s discuss that point about the US deficit a bit more. With the United States trade deficit remaining in the trillion dollar range for the foreseeable future, changing the global supply chains may be impossible without major disruptions to the US and world economies. If US support for the world economy were withdrawn by reducing the excess demand, the costs to the world economy would be substantial and long lasting as would be the cost to the American economy. Imagine removing 73%of the clothes in a US department store or 35% of the medical care and drugs from US pharmacies. Chaos.

Looking Ahead: QuERI’s 5 Principles to Solve Global Trade Imbalances

Like budget deficits, trade imbalances may be just a fact of global life, the costs associated with the collective choices of individuals, companies, and governments. On the other hand, equally beneficial participation in global value chains for advanced, emerging, and developing countries is impossible without balancing multilateral trade flows and preventing the erosion of the manufacturing base in many countries and concentration of productive capital in few others.

QuERI modeling estimates show that the world economy will recover quickly and return to its pre-covid growth path, but for a group of developing countries the COVID-19 pandemic significantly impaired the long-term growth outlook, shifting average annual growth rates to about 1 percentage point below pre-COVID modeling estimates.

So, how do we get to a new framework? According to QuERI, a new approach to global trade policy can be based on the following five general principles:

Principle 1: Trade must be fair and balanced if it is to be useful and equitable.

Principle 2: Any tariff applied must be non-discriminatory and divorced from any single country or product flow.  The world is far too complicated and interrelated to allow governments or even experts to select winners and losers.

Principle 3: The damage from imbalances impact both the countries in surplus and the countries in deficit equally, thus the remedy must be applied to both sides of the equation.

Principle 4: Trade policy changes must be made collectively, not unilaterally. The United States should propose and lobby strenuously for a revision in the WTO compact that requires annual review of trade account balances, with direct recourse to ad valorem import tariffs or excise taxes to bring imbalances within an agreed range as a share of GDP. When countries regain some balance, then tariffs will be less necessary and serve only as an automatic stabilizer to the benefit of the long-term health of countries and world economic prosperity.

Principle 5: Don’t decide winners and losers. Companies understand their supply chains and the costs they incur better than do policymakers. Applying tariffs on all imports eliminates the ability of companies to switch suppliers from one country to another with the only recourse to choose between foreign suppliers and domestic suppliers. A 10% increase in expenses on 30 or 50% of inputs may place manufacturers at a disadvantage against competitors who have far smaller bills for imported inputs, leading them to adjust sourcing to remain competitive and profitable.

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Based on the original article by Dr. David L. Blond, Principle Researcher and President, QuERI-International. QuERI International helps businesses and governments quantify the world through use of sophisticated and integrated econometric modeling and forecasting. Based on over 40 years of economic forecasting experience, QuERI’s proprietary models cover 72 countries and 166 ISIC 3 industries and commodities with all data based on a consistent definition and units of account. Learn more about QuERI-International here.

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Based on the original article by Dr. David L. Blond, Principle Researcher and President, QuERI-International. QuERI International helps businesses and governments quantify the world through use of sophisticated and integrated econometric modeling and forecasting. Based on over 40 years of economic forecasting experience, QuERI’s proprietary models cover 72 countries and 166 ISIC 3 industries and commodities with all data based on a consistent definition and units of account. Learn more about QuERI-International here.