Greek Business File, June-July-August 2020, No 126


Emerging markets and low-income countries will be faced by a synchronized deep crisis in the following months, estimates Elias Papaioannou, Professor of Economics at LBS. The big problem in Europe, he adds, is that each country’s capacity to cope with the health and the economic crisis differs wildly


Can you briefly tell us what is happening to the World Economy during this phase of the pandemic?

Covid-19 was a shock that initially hit emerging economies (China), industrial countries (Italy and South Korea) and frontier economies (Iran). And it quickly spread around the world, without much discrimination. Some advanced economies responded wisely with lockdowns and were quick to test, like New Zealand and Denmark, others failed, most notably the United States and the United Kingdom, which have failed big time in their early response.

However, when we think about the economics of the pandemic, the situation is quite different. Due to the countries’ considerable gaps in fiscal space, the credibility of monetary authorities, and institutional quality, the shared shock will, sadly, yield divergent economic trajectories.

The two extremes

Would you look for a First world/Third world gap?

Take the United States, which is the extreme case. The Federal Reserve has implemented, swiftly and decisively, various quantitative, easing programs, crucially assisting the economy: support for banks, assisting big corporates to roll over their debt, funding states, indirectly helping small- and mediumsized enterprises and many more. At the same time, the fi scal stimulus package has been both big and far-reaching. Though targeting should have been better, assisting workers and small business and entrepreneurs rather than big corporates, the US’s unique position in the international financial system allows her to borrow very cheaply and assist its economy.

At the other extreme stand emerging markets and frontier economies, such as Turkey, South Africa, Argentina, and  Indonesia. First, they are faced with an exodus of capital, as investors are looking for safety. This impacts public finance, the ability of banks to fund micro-enterprises, households, as well as corporates in these countries whose access to international capital markets has been blocked. Second, it is the commodity price decline that affects commodity exporting countries, like Nigeria, South Africa, and Russia. This has first-order implications, as for example the Nigeria budget depends almost exclusively to oil exports. Third, it is the health crisis that can have severe and deadly eff ects in low- and middleincome countries, whose health systems are underdeveloped, under-funded, and disorganized. I am afraid that in the following months we will be seeing a synchronized deep crisis in emerging markets and low-income countries.

The big problem in Europe

And what about Europe? Is there a new North/South divide?

The Eurozone is closer to the US, though there are no negligible asymmetries. Let’s start with the Eurozone. The European Central Bank responded aggressively, helping both European banks and governments. Banks can access much-needed liquidity and hopefully they will soon be able to resume their crucial function, lend businesses and households, fund innovative entrepreneurs and corporates. The ECB has helped crucially governments that turn into the markets to fund expansionary fiscal programs. On the fiscal policy side, there are both good and less-good –I wouldn’t say bad– news. First, the countries of the core, most notably Germany, have announced and started implementing sizable fiscal stimulus programs. These programs are well-designed targeting workers, small and large businesses and households.

While they are primarily targeting the domestic economy, there are going to be positive spill-overs to neighbouring countries and the periphery. Second, the Eurogroup and the ESM (European Stability Mechanism) have taken some steps to assist Italy, Spain, and other countries that have suffered the most from the health crisis. For example, the relaxation of the tight fiscal targets is a sound measure and so is the financial assistance, which though quite limited, it is a step in the right direction.

The big problem in Europe is that each country’s capacity to cope with the health and the economic crisis differs wildly. For example, Germany, Austria, and the Netherlands have ample fiscal space that allows them to protect workers and firms and invest heavily in the health system. Nonetheless, this is not the case in the European South, as Italy, Portugal, and Greece have high debt levels that places constraints in their effort to protect workers and firms.

I am optimistic that EU governments and policy institutions will soon reach a reasonable compromise. That’s the good news. The bad news is that on the marketing side the EU has performed poorly. In such a severe health crisis, European citizens expected more solidarity to Italy and Spain, more empathy, and more assistance.