The world economy has been going through a lot. The war in Ukraine broke out while the world was still grappling with the fallout of two years of the Covid-19 pandemic, an event that led to the most inclusive global recession since the 1900s and bigger than the two world wars and the Great Recession in terms of the countries affected, Carmen Reinhart, senior vice president and chief economist of the World Bank Group recently told participants at the 28th annual conference of the Economic Research Forum (ERF).
In 2020, the largest ever share of countries globally saw simultaneous contractions in GDP, she told the conference, entitled “Revisiting Macroeconomic Management in Times of Crisis and Beyond”.
The recovery has been different and uneven, Reinhart noted. The diversion between advanced, middle-income, and low-income countries has also been large. Many emerging markets and developing countries were struggling even before Covid-19. Most economies have seen rebounds, but few have fully recovered.
Higher inflation is not helping. While there is talk of overheating causing inflation because productive capacity is unable to keep pace with growing aggregate demand, it is not the main driver, Reinhart said.
Rising commodity prices, breakdowns in supply chains, and the war in Ukraine are all adding to an already sharp comeback in commodity prices, she noted. This has been further augmented by currency depreciations, capital inflow retrenchment, and sovereign credit ratings downgrades.
Food prices are a big concern, Reinhart said, because they have regressive consequences. Whereas food represents around 15 per cent of the consumer price index basket of goods for high-income countries, it is much higher for emerging markets and developing countries at around 40 per cent and higher.
The hit to household budgets as a result of rising food prices mostly affects the most vulnerable households and on a global level affects emerging markets and low-income countries the most.
In this setting, Reinhart said, policymakers, including governments and central banks, are facing a precarious situation.
The tighter monetary policy that the US Federal Reserve has begun to implement in the shape of raising interest rates will mean debt-servicing costs for many countries will rise. Risk aversion in capital markets means capital flows are also likely to diminish and become more volatile as international interest rates rise.
The last time that the US was battling high inflation in the late 1970s, the Federal Reserve raised interest rates by 600 basis points, Reinhart noted. Inflation in the US is currently at a 40-year high.
With rising interest rates and a precarious economic situation, Reinhart warned that countries will have to pay great attention to debt management. Debt-servicing burdens have been rising markedly for about a decade, even with exceptionally low global interest rates, she said.
“Minimising rollover risk is critical. It is at times like this that rollover risk increases and what often starts as a liquidity crisis can end up as a solvency crisis,” she said. Rollover risk is when a loan or other debt obligation is about to mature and is “rolled over” into new debt.
Reinhart also warned against borrowing from central banks. Over the last two years, she said, there has been a tendency to finance the larger deficits associated with collapsing revenues caused by declines in economic activity by borrowing from central banks.
But countries that have routinely relied on financing from the central bank have ended up with double-digit inflation rates, she said. “The temptation to finance domestic debt through central bank purchases carries many risks. One of those is currency crashes and seeing more instability in the currency,” Reinhart said.
To overcome rising debt, Egypt’s Minister of International Cooperation Rania Al-Mashat said the international community must come up with innovative financing solutions to help emerging and developing economies.
Speaking to conference participants, she noted that issues such as the UN Sustainable Development Goals (SDGs) and climate finance were being hijacked by what is happening in the world economy. The exit from all this requires coordinated effort, Al-Mashat said.
“We [the world] coordinated during Covid to create COVAX [the Covid-19 vaccination programme]. This is another shock that requires collective effort… there are enormous financing needs for all countries globally,” she said.
Reinhart shares the same concern that the shift towards a greener economy is going to be put on the back burner because of shrinking fiscal space and the need to put out fires. “Historically one thing that tends to happen is reversals in economic fortunes lead to reversals in policy. That is something to be watchful for, especially when we have policies that we cannot delay even longer, like climate change policies,” she stressed.
Dani Rodrik, Ford Foundation professor of international political economy at the Harvard Kennedy School of Government in the US, addressed the conference about the future of development strategies.
“We are going through a period of transition in the world economy, and one gets the feeling nothing will be the same afterwards,” he said, noting that the context of the world economy is changing with concerns about national security becoming more dominant than economic development.
Many of the gains that were made in poverty reduction and global development over the last four decades are being reversed, he said. There is a sense that the overall context for economic development is fundamentally altered, and there is a need to think about development in a different way, Rodrik said.
“Growth policy and social policy increasingly become one and the same: we cannot have growth without creating productive jobs and expanding middle class and cannot address structural factors behind poverty and inequality without creating good jobs for relatively low-skilled workers,” he said.
He said that most advanced economies had grown by becoming more industrialised and creating jobs in the manufacturing sector and away from agriculture. What was special about manufacturing industries as a growth driver, he said, was that they were traditionally labour intensive.
However, Rodrik noted, even countries that have successfully followed the path of industrialisation are now seeing the sector employing less people. The reason for this is global technological change, he said, explaining that manufacturing has become more technology based, employing highly skilled labour.
This, he said, means that firms in developing countries that want to compete globally must adopt high-skilled and capital-intensive technologies and cannot absorb the low-skilled labour found aplenty in the developing world.
That being the case, Rodrik said a much greater role will have to be played in the future by the domestic services sector.
However, he noted that good jobs require good firms and called for a mixture of interventions in education and training the labour force and for policies that enable good firms to grow.
To achieve the latter, he suggested customised assistance to firms with soft conditionality on job creation, instead of subsidies and tax incentives. Firms also need access to elements such as a stable, skilled workforce, technology, and contractual and property rights enforcement, he stressed.
The government also needs firms to create good jobs through employment, training, investment, and technological choices.
*A version of this article appears in print in the 7 April, 2022 edition of Al-Ahram Weekly.